Description
Introduction:
We are recommending going long Brasil Agro (AGRO3), which we
believe to be one of the cheapest and most unique investment opportunities in
the agriculture space providing between ~35% upside (project NPV of fully
deployed IPO cash proceeds) and ~70% (30% premium for less conservative project
assumptions and Brasil Agro’s ability to deploy additional capital). The
company’s core business is the acquisition, development and resale of
agriculture land in Brazil.
Currently investors are able to buy Brasil Agro at a mere R0.60 premium to its’
IPO cash proceeds assuming full warrant dilution. We believe over the next year
Brasil Agro will appreciate as the dramatic re-valuation of its’ land banks
becomes apparent. Our upside target becomes more likely as Brasil Agro sells
off mature sugarcane assets, deploying capital more efficiently than our
conservative base case assumptions. While not directly incorporated into our
valuation, we believe investors could receive a multiple of their original
investment if Brasil Agro becomes a platform off of which additional capital may
be deployed above management’s 25% IRR hurdle rate. Cresud’s (Argentine analog
and 10% owner of Brasil Agro) tremendous shareholder returns demonstrate the
multiyear return potential if the company is able to build a business platform
to source and develop future land projects.
Valuation:
We believe that shares of Brasil Agro are worth between 35%
(~13.50 reais) and 70% (~17 reais) more than its current share price of 10 reais.
On the low side, we arrive at a valuation of ~13.50 reais based on the
following sum of the parts:
1. Cash
balance: R552mln
2. NPV
of committed land projects: R170mln [Project details below]
3. NPV
of future land projects from IPO capital: R125mln
4. NPV
of cash received from warrants: R101mln
Total EV: R948mln
Post-exercise shares outstanding: 70.1mln
Value per share: ~R13.50
Business:Brasil Agro will develop its ~120,000 hectares of land
holdings (purchased or agreed purchases) into ~110,000 hectares of soy farmland
and ~10,000 hectares of sugar cane farmland. Of Brasil Agro’s announced
projects, we assume that only ~4500hectares (Sao Pedro Farm, Engenho Farm) of
its ~120,000 hectares of farmland holdings will be sold before full maturity in
FY2012. This conservative cash flow assumption (some might say poor capital
allocation) lowers project IRR’s to 39% and raises maximum capital deployed to
~R260mln. Our forecasting assumptions are as follows: 5% per annum appreciation
in sugar farmland (~R10900/hectare ending value), 10% per annum appreciation in
soy farmland (~R5850/ hectare ending value), 12.5% cost of equity capital, 7%
tax rate and R39 per bag of soy.
For the remaining excess capital, we assume that the
remaining ~R290mln in cash will yield an NPV of ~R125mln when deployed in one
year’s time with a project IRR of ~30% with otherwise similar assumptions to
the firm’s existing projects.
Our upside target is an approximation to account for more
efficient capital deployment, especially the utilization of 6-7% economic
development bond borrowings. Additionally, it allows for value creation through
the deployment of cash received from warrants being exercised. To understand
the return potential on future capital deployment, we encourage investors to
acquaint themselves with Cresud’s history.
Management:
Perhaps one of Brasil Agro’s
greatest assets is it management team and investor base.
- Cresud,
which owns approximately 9% of Brasil Agro, is one of the largest
landowners in Argentina.
Cresud has used this business model successfully for years in Argentina
and is closely involved in the day-to-day operations of Brasil Agro with
numerous appointments to the board of directors. Conversations with Cresud
management made it readily apparent that Brasil Agro is viewed as an
important growth outlet for the firm.
- Elie
Horn is one of Brasil Agro’s largest individual shareholders. Elie Horn is
Chairman of the Board and controlling shareholder of Cryela development
(the largest player in Brazil’s
commercial and residential development market).
- The
Elzstain family holds various personal stakes in Brasil agro. The family
through it association with Cresud and Irsa in Argentina have more than 20
years experience in the development in real estate and agriculture
projects.
Cresud, senior management and
larger shareholders have commented both privately and publicly that they are
interested in increasing their stakes in Brasil Agro through open market
transactions. They will also increase or maintain their relative position size
if the company raises further equity once capital is fully deployed
Business Description:
Brasil Agro’s business economics are primarily driven by two
factors:
- Expertise
and relationships allowing the development of raw land into more valuable
farmland.
- Unsustainably
attractive differentials between global and Brazilian farmland.
Detailed Business Description:
- Brasil
Agro has a unique management team, set of financial backers and business
partners that allow it to generate excess returns by developing land,
either raw or other use, into much more highly valued farm land. The
following table illustrates the valuation differentials between different
types of land:
Example of land valuations in Brazil
(USD per ha)
Unproductive Land-
less than $400 per hectare
Cattle Land ~ $800 to $1000 per
hectare
Soy Land ~$2000-$2500 per hectare (
R3500-4400 per ha)
Sugarcane Land ~ $5000 per hectare
(R8900 per ha)
We discuss the management team and financial backers within
the management section. Brasil Agro has an exclusive relationship with Brenco,
a Brazilian ethanol producer, which allows Brasil Agro to purchase and develop
land in advance of Brenco’s future sugar cane mill announcements. We discuss an
example project in “Other topics to discuss.”
By buying large underdeveloped tracks of land and investing
capital for soil correction, irrigation and new seed selection the company
should be able to realize significant returns on invested capital. For example,
they currently are transforming unproductive cerrado into cleared cattle
farmland, cattle farmland into soy crop and soy crop into sugarcane
plantations. Each step of this process creates significant price appreciation
as the crops move up the value chain. Brasil Agro is currently involved in each
step of this process and is able to enter at various points of the value curve
- Brasil
Agro is able to take advantage of “relatively cheap” agriculture land in Brazil.
Regarding soy farmland, a hectare of soy land in Brazil sells between 1500 to 2500 USD while
a similar hectare in the US
would be 7000 to 10,000 USD. With
similar crop yields and our assumed R4000 per Ha soy land price, we
calculate the minimum incremental pre-tax return to the Brazilian soy
farmer at ~16% [Assumptions: $10 per bushel, $7 per bushel cash costs, 40
bags per hectare yielded, R1.776 per USD, 60lb per bushel, 60kg per bag].
Within our model, we forecast soy farmland prices will appreciate 10% per
annum for the next five years. We feel comfortable with this forecast
given: 1. Argentina’s farmland sells for a much smaller gap to US
farmland, providing comfort that the US tariff regime does not justify
such a large gap; 2. Brazilian farmland has appreciated at 10-20% rates
over the last four years; 3. We believe that yields will improve to 50 bags
per hectare, keeping returns above 15% [11% without improved yields]; 4.
Our model does not account for improvements which will lower Brazilian soy
farming costs, especially related to infrastructure. Regarding sugar cane farmland, we calculate
the minimum incremental pre-tax return at ~18%, but do have the same data
granularity as our estimates in soy production. However, we are
comfortable with this given the low sensitivity to sugar farmland prices
and continued soy to sugar farmland conversion which attests to the
relative economics.
Other topics to discuss:
- The
company has placed all newly acquired assets in individual subsidiaries.
Under a REIT like structure these subsidiaries are able to sell assets
below R50 million at a 7% gross tax rate. The subsidiary is allowed one
asset sale larger than R50 million at 7% gross tax rate but then must
begin paying normal tax rates. However, limited costs and no legal
barriers make it easy to simply create new subsidiaries (they mirror tax
strategies used at Cryela).
- Speaking
with management the company is putting Engenho and Sao Pedro assets up for
sale. These assets were originally acquired in late 2006 for R9.9 and R10.1
million respectively. The company intends to sell each asset for as much
as R20 million. Representing a doubling in value in a little less than a
year
- Brasil
Agro currently has an agreement with Brenco to develop 10,000 ha sugarcane
crops at each of its future projects. These contracts should prove to be
extremely valuable to Brasil Agro as Brenco is building its future mills
on marginal land within Brazil.
This allows the company to purchase soy land in advance of the mills
production (2000-2500 USD per ha) and turn the land into sugarcane crop (5000
USD per ha) within a three-year time frame. Currently the company is
pursuing this strategy at Alto Taquari and Araucaria farms.
- Brasil
Agro in many cases has worked out extended payment agreements to farmers
or co-ops in order to extend cash outflow over a two to three year period
when acquiring assets.
- Brasil
Agro is able to take advantage of economic development bonds when
improving assets. These essentially allow the company to borrow at 6-7%
rate while holding short term investment paying 10-11% (cost of debt to
cash arb)
- Warrant
structure: The company has a 2 series warrant structures. The first series
allows founding shareholders to increase the total capital by 20% of
shares outstanding over a three-year period (vesting 1/3 per year). The
strike on these warrants is at IPO price (R10) indexed to IPCA inflation (NPV
of the strike at ~R8.6). The second series is enacted in the case of a
take-over. Foundering shareholders are able to buy 20% of fully diluted
shares outstanding at the same offer price as the bidding acquirer. Our
calculations presume full exercise as this is in the owner’s best interest
and results in the lowest valuation.
Operations:
While the primary focus of the company is to acquire and
redevelop assets the business will involve a significant amount of farming
operation. By the beginning of 2009 the company intends to run ~18,000 acres of
soy, growing to over 30,000 hectares prior to sales on existing projects. While
it is hard to forecast operating earnings for this business due mainly to
fluctuating crop prices we feel a 35% EBITDA margin to be appropriate (normally
range between 25 and 45%). While we believe there is value created in
day-to-day operations we view this business as an ancillary means to an end. The
company will not be spending capex on farm equipment, as it wants to minimize
operational capex. Instead it will lease the machinery and in many cases
outsource labor.
Risks:
·
Soft commodity prices collapse
·
Land prices increase slower than expected or
decline
·
The company is unable to find viable acquisition
to meet investment targets
·
Competition intensifies and returns on future
projects fall
Catalyst
· Company is able to sell Engenho and Sao Pedro farm in 2008 for double acquisition cost
· Cresud/Management/Larger shareholders continue to acquire more shares
· Company fully deploys capital
· Further coverage from larger sell side banks