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For us to invest, JBS's governance must match its financial strength

When analysing a company, we consider the full spectrum of its performance: credit profile, operations and sustainability risks. In meat producer JBS we see a business with strong financial, environmental and social performance but have reservations about its corporate governance. In our view, as one of the key protagonists in Brazil’s 2017 meat-industry corruption scandal, the business needs a stronger and more independent board in order to truly move on from its tainted past.

Key points

  • Brazilian meat producer JBS came close to a severe liquidity crisis in 2017-2018 amid a bribery scandal, but the firm has since reduced its short-term debts and stabilised its liquidity profile.
  • We exited our position in JBS in late March 2017 on concerns about corporate governance and culture, before the full scale of the crisis became apparent. But if the company can remedy these flaws, we think its investment merits would improve due to its strong business and environmental and social risk management.
  • We believe the market is overlooking the company’s governance problems because its credit performance has recovered. In our view, it is time for renewal at the top so that an independent, diverse and effective board – one of the main pillars of strong corporate governance – can lead.

Corporate scandals are not scarce, but few are so significant that they lead to calls for the president of the home nation to be impeached1.

Brazil’s Carne Fraca – or ‘weak flesh’ – scandal of 2017 makes meat producer JBS one of those outliers. By bribing 1,829 officials to enable poor-quality and allegedly spoiled meat to reach consumers, the Sao Paulo-based firm emerged as another participant in a series of Brazilian bribery scandals that saw prosecutors point fingers at three consecutive presidents: Lula da Silva, Dilma Rousseff and Michel Temer2.

In May 2017, JBS agreed to pay a record fine of 10.3bn real (£2.4bn) after the brothers who control the business, Wesley and Joesley Batista, confessed to handing 600m real of company funds to more than 1,900 politicians3. Then-President of Brazil, Michel Temer, was directly accused of accepting bribes based on evidence provided by the brothers4

In our view, JBS’s conduct provides a prime example of how a lack of effective corporate governance can undermine an otherwise strong business and lead to losses for investors.

Taking a fresh look

Such malpractice is lamentable – not only for ethical reasons, but for financial considerations too – because in its absence, JBS is an appealing company.

JBS employs more than 230,000 people worldwide and has customers in 190 countries. It grew through a series of acquisitions by the Batista brothers and was financed by a public stock offering and funding from Brazilian development bank BNDES. The company today has 51% of its operations in the US, 15% in Asia and 13% in Brazil5.

An impressive 24% of JBS’s exports go to Greater China – its largest export region by volume – giving it welcome exposure to the extraordinary growth of meat-eating middle classes in the nation6.

JBS is diversified across multiple meat products and has evolved from a purely protein-based company to a provider of value-added products such as antibiotic-free and specialty meats.

Financials: on the right path

JBS came close to a severe liquidity crisis in 2017-2018 amid the bribery scandal, but the firm has since reduced its short-term debts and stabilised its liquidity profile, chiefly by achieving a so-called normalisation agreement with creditor banks in May 20187. This enabled JBS to continue to access credit lines until July 2021, avoiding a debt-repayment crisis and leading to credit-ratings upgrades.

The company is correctly focusing on cash flow generation and deleveraging. It has also completed a series of asset sales to improve its liquidity. JBS also aims to enhance its cost of capital by optimising its capital structure which should be achieved by floating a subsidiary, JBS Foods International, on the US stock market – something the company has aimed to do since late 20168. Plans were stalled by the bribery scandal but are now back on the table9.

JBS has also achieved some success in reducing its short-term debt, which stood at 5.5% of short-term debt at the end of the first quarter of 2019 compared with 31% before the 2017 crisis became public10.

The first-quarter performance announced by JBS yesterday was mixed but indicates that the business remains healthy. The company’s global reach, diverse lines of business and strong operations have been aided by a positive beef cycle across the industry and a focus on improving efficiency and margins through an improved product mix and innovation.

Engaging JBS on ESG

By Jaime Gornsztejn, Director of Corporate Governance – Hermes EOS

Since being fined as a result of the Carna Fraca investigation, JBS has taken steps to restore the confidence it betrayed in export markets.

More broadly, on environmental and social issues, the company continues to make progress, including the development of a compliance programme led by a reputable Head of Ethics and Compliance, and the implementation of tools to monitor deforestation and to audit meat quality.

We have engaged members of the senior management team and board, and continue to discuss issues ranging from deforestation caused by the meat industry to food safety. We are consistently pleased by the company’s management of environmental and social risks. For example, in 2009, JBS committed to cease purchasing cattle from suppliers involved in deforestation. It now uses digital maps in conjunction with a satellite-enabled surveillance system to monitor each property that it sources cattle from. We were also reassured by the extensive human and technical resources that JBS dedicates to food safety, which includes testing laboratories in each plant and regular audits – conducted internally, and by some of its major clients.

On governance matters, JBS has recently appointed a new Chief Executive Officer and Chief Financial Officer, both of whom were not associated with the 2017 scandal. But broader problems persist. For instance, the firm’s former investor-relations director now serves as Chairman, casting doubt over the board's independence from the executive. In fact, most board members still remain either too closely connected to management or the Batista brothers, in our view. 

The Batista family owns 40.52% of the company's shares, according to JBS investor relations, with 21.32% held by BNDES in an agreement with the Batistas, effectively removing them from the free float. Since JBS only issues voting shares, this means the family has a controlling portion of shares and makes it too influential in the company’s affairs, in our view. Moreover, the company continues to resist pressure from us to audit how the ongoing presence of Wesley and Joelsey Batista is impacting the company’s interests.

Time for change

JBS’s credit performance has recovered since the scandal broke, leading us to think the market might consider the company to have moved on from the scandal and its governance problems. However, because we consider ESG factors and engagement insights alongside credit and operating risk in our analysis of companies, we will not be confident in JBS as a potential investment until we see meaningful improvements in its corporate governance. In our view, it is time for the Batistas to step aside and let an independent, diverse and effective board – which is one of the main pillars of strong corporate governance – lead the company. This would be in the best interests of the business and its investors.

Risk profile
  • This document is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments.
  1. 1“Lawyers vote for Brazil president’s impeachment,” by Andres Schipani. Published in the Financial Times on 21 May 2017.
  2. 2Based on documents from the Prosecutor General supplied to the Supreme Court, citing evidence supplied by Wesley and Joelsey Batista of JBS as part of their plea bargain.
  3. 3“Brazil meat-packing giant JBS to pay record $3.2bn corruption fine,” published by BBC news on 31 May 2017.
  4. 4“Brazil’s Temer faces new graft charges over JBS testimony,” by Brito, R. and Boadle, A. Published by Reuters on 14 September 2017.
  5. 5Source: company website.
  6. 6“Meeting with investors,” published by Marfrig Global Foods in January 2019.
  7. 7“JBS signs normalisation agreement with financial institutions in Brazil,” an investor-relations notice published by JBS on 14 May 2018.
  8. 8“JBS S.A. announces that its subsidiary JBS Foods International B.V. plans to conduct a registered initial public offering In the U.S.,” an investor-relations notice published by JBS on 5 December 2016.
  9. 9According to a JBS earnings call for the third quarter of 2018.
  10. 10According to JBS earnings presentations for the first quarter of 2019 and fourth quarter of 2017.

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