Alpargatas is a historic footwear manufacturing company (oldest company still traded in the Brazilian exchange), with a rich history in Brazil and Argentina, creating category-defining brands in both countries. Like any old company, its portfolio has changed a lot over the years.

Today, Alpargatas’ only relevant asset is Havaianas, the largest flip-flop brand in Brazil, and, one could argue, maybe globally.

Within Brazil, Havaianas sells 200+ million pairs per year (almost exclusively flip-flops). This implies a 65%+ market share in the flip-flop category, and a 50%+ share within the wider sandal+slipper category.

Havainas sells 1 in every 4 pieces of footwear in the whole country! It’s branded-staple quality renders it similar to Coca-Cola: a product that carries the strongest psychological effects of brand power and yet is within the reach of anyone.

Outside of Brazil, Havaianas sells another 20 million pairs, which is a drop in the bucket of the global market (maybe as large as a couple billion pairs). However, Havaianas’ positioning outside of Brazil could eventually allow it to become a silhouette brand. Similar examples include Birkenstock, UGG, or Crocs. That is, internationally, Havaianas always holds the potential for very interesting convexity.

The business today has recovered from a deep downturn after the pandemic (classic inventory glut). It combines what I believe is a branded-staple product in Brazil that has a good ability to generate relatively stable earnings, with the potential of expanding that brand power to a massive category outside of Brazil.

This article covers the company in detail, including positioning in each market and segment, financial analysis, operational leverage models, taxes, management quality, capital returns, etc.

Vamos lá!

Eu dou amor e o povo me machuca

Meu coração tá igual havaianas, todo mundo usa

I give love but the people steps on me

My heart is like Havaianas, everybody uses it

Havaianas - Som de Faculdade

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. I may own or later purchase some of the stocks mentioned in this article.

TLDR

• Havaianas in Brazil is a business that combines staple volumes with branding power and the potential to expand margins via trade-up during good consumer periods. The business showed resilient volumes and margins in 2014-2018. During the post-pandemic glut, it suffered more but still turned a profit. Clearly, among the most valuable consumer brands in the country

• Havaianas International offers the potential for growth, but so far, this has proven hard to execute. The business will require significant recurrent investment (and therefore low profits), but the potential is huge.

• Capital returns are high (15% NOPAT/Operational Assets). Unfortunately, the capital returns cannot be leveraged, and there’s not a lot of space to put capital to work. Has a strong history of dividend payments.

• The valuation today seems a little dear or “quality-like” for Brazilian standards, based on what I believe is a more recurring earnings level. This seems justified by the quality of the brand/business, and is below historical standards, but it’s hard to think of high returns from these prices, unless one is rather optimistic about Brazil or abroad, or expects further multiple expansion.

• Still, it is at the top of my list for a Brazilian downturn.

Index

• Brazilian market - Chinelos e feijão

  • Intro and history

  • Staple segment

  • Differentiated segment

  • Estimating volume and sales by channel and segment

  • Going forward

• International market - Cost of growth

• Other businesses

• Financing and capital requirements

• Taxation

• Post-pandemic operations

• Management quality

• Models and scenarios

  • Past and present consumer cycles

  • Operating leverage model in Brazil

  • International scenarios

• Capital returns and valuation

Brazilian market - Chinelos e feijao

Brazil represents 90% of the volume, 75% of the revenues, and 95% of the EBITDA of the brand today. It is the heart of the brand.

Sandals are the dominant footwear category in Brazil (380 million pairs, or 45% of the market). This makes a lot of sense, being a tropical country (blessed by God and beautiful by nature, we should add). Dominating the largest market, Havaianas is the largest footwear seller in Brazil (~25% of the whole market).

I don’t think any other global footwear brand can claim 25% market share of a large country, across all categories. The brand sells, on average, one pair to each Brazilian per year.

This moves Havaianas from footwear to a form of staple product, with some volatility given by the cycle, but overall, fairly stable characteristics, particularly around volumes.

Havaianas was created in the 1960s and for its first 25 years it was primarily the footwear of the people. During the 1980s inflation crisis, the government put Havainas in the controlled price list. However, its original popularity, low price, and simplicity, had converted it in a form of inferior good.

Then, in the early 1990s, Alpargatas decided to elevate the brand via massive marketing campaigns, generally starring personalities from Brazil and transmitting a feel-good attitude (the most recent example has Vinicius Jr, Brazil’s most relevant football player today). The core slogan became ‘Todo mundo usa’ (Everybody uses it).

The brand grew like wildfire in the 1990s and 2000s: in 1993 it reached 100 million pairs, by 2005 it had grown to 136 million pairs, and then added another 70 million pairs in the next 7 years.

However, the brand has been unable to surpass the heights reached at the peak of the Brazilian boom in 2012/14.

Even though it has not represented growth, the brand’s volumes have been extremely resilient to severe crises in Brazil (2014-2019, 2021/23). The volatility of volumes seems more related to channel stuffing/destuffing than to end-demand, which seems fairly stable at ~205/210 million pairs per year.

Staple segment

Havaianas' stapleness is evident in its price and in its distribution channels. The cheapest pairs can retail for R$25/30 ($5 each), and 65% of the brand’s volume is sold in grocery stores, supermarkets, and pharmacies.

40% of the volume, skewed towards the cheapest options, is sold in local, small-scale groceries. You go and grab some rice, some feijao, and a pair of Havaianas. For stores, the Havaianas is a high-impulse but recurring sale, usually in the hot area of the store (example). This market is served by a network of also relatively small distributors and resellers (example, example, example).

The distribution in this particular channel (small-scale grocery, where the company claims a whopping 87% share) is probably a particular challenge and a source of moat. Whereas rice is the same for all customers, stocking sandals is a different game altogether because there are quite a few more SKUs (sizes to begin with, but also colors and styles). This is a long chain. The small store buys from a reseller in the commercial district of the city, who then buys from a larger distributor, and so on. It is also probably a source of volume volatility, in the form of the inventory bullwhip effect.

Differentiated segment

As mentioned above, Havaianas is not only a staple brand, but has also tried to capture higher-differentiation segments above the cheaper options.

Today, one can find a variation of the classic silhouette at R$140, or variations of the silhouette for R$250+. In the traditional footwear channel, like shoe stores and apparel stores, the majority of sales belong to these upper-price categories.

Estimating volume and sales by channel and segment

The company only reported in its Investor Day the volumes by channel, and the sales percentage by segment and channel.

However, based on only two sets of assumptions, we can estimate/speculate around the aggregate volumes and sales by segment, channel, and combination.

The two assumptions are:

• The sales price across channels is the same for a specific price segment. That is, the company sells a basic product for say R$5 to Grocery Trad and to Grocery Modern or DTC. This is not true (the longer the chain, the lower the sales price, so one piece sold to Grocery Trad probably represents less revenue than if sold to Specialized or via DTC), but I haven’t found any info on which to work around it.

• The price relation between the segments, which I estimated as 1x for Basic Low, 2x for Basic High, and 3x for both Premiums (Premium Low is irrelevant). Again, someone might question this, but it is what I found most reasonable.

What we find is quite interesting:

• The sales share of the channels is similar to their volume share, with a little underweight in Grocery (more cheap products) and overweight to Specialized (more expensive products).
  Overall, though, the 55/45% rate between grocery and specialized+DTC is maintained as a percentage of sales.
  This makes sense given that the grocery businesses still sell a relatively premiurized product (30% of sales are premium models, 40%+ are upper basic).
  The highly protected (in my opinion) traditional grocery business still retains a high percentage of sales, similar to volumes.

• The basic models make up 65% of volumes and 50% of sales across all channels. Interestingly, premium models make up 50% of sales and 1/3 of volumes, and the upper basic models make up anothet 35% of sales and 1/3 of volumes. This strikes me as a high level of premiumization. This is even true of grocery trade, where premium models are 30%+ of sales, and 1/5 of volumes.

Moving forward, I do not see significant challenges or opportunities in the Brazilian market, but rather a profitable and defensible market. The brand has to defend its position from its own mistakes, especially by not milking the cash cow excessively to the point of alienating lower price points or disinvesting in marketing.

Going forward

Read more

The Brazilian stock market has been taking a huge dip since its earlier, fairly impressive start of the year.

In addition to this, the investable universe of Brazilian-listed stocks is now much larger, at least for me, given that the B3 is now accessible to foreign investors through IBKR.

I have been looking at names screening for cheap valuations mainly. Most of them sit comfortably in the micro cap region (~$80 to $300 million market caps), and could be classified as deep-value, trading at MSD PE multiples or even LSD EV/EBIT multiples.

However, as always with such companies, the devil is in the details. Sometimes earnings are not really recurrent or durable, or there are hidden balance sheet factors, etc.

This article is a selection of six names that caught my attention the most. My analysis tries to acid-test the apparent cheapness of each name, focusing on risks and hidden factors.

Hope you guys like it.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. I may own or later purchase some of the stocks mentioned in this article.

Index

• Valid Soluções- $VLID3 - R$1.4 billion

• Wiz Co Participações - $WIZC3 - R$1.2 billion

• Dexxos Participacoes - $DEXP3 - R$820 million

• Allied Tecnologia - $ALLD3 - R$500 million

• Qualicorp - $QUAL3 - R$430 million

• Meliuz - $CASH3 - R$420 million

Valid Soluções- $VLID3 - R$1.4 billion

• Large player in ID and documents (Brazil), mobile SIMs (global), and credit cards (Brazil and Argentina). Some of the businesses are pressured from competition (payments) and others by technology (payments, mobile). Trying to switch towards more digital revenue, it's not easy.

• Their businesses seem to be in a neutral to negative position. Growth will be hard/expensive, and there’s always the risk of cannibalization/obsolescence.

• Although the name screens cheap (PE of 5/6x), in reality, its earnings power is closer to a PE of 8x.

At first sight, Valid seems like an easy thesis: “Good margin businesses pressured by technology, already showing signs of that impact, very discounted PE for that reason, falling knife business”. My read is very similar, only that the PE is actually not that discounted.

Businesses and perspectives

Valid’s operates in three main segments, all related to hardware-based security, and digital infrastructure related to that

Identity and documentation (50% of revenues, 75% of EBITDA)

One of the largest processors of IDs and driving licenses in Brazil. The business is based on government bids. Adjacent legacy businesses include the issuing of securitized documents (anti-forgery and such characteristics).

The company is also expanding into other government areas like digital certificates, smart cities, and is trying to enter other identity-management software-based services like KYC and authentication. This seems harder to do, particularly for B2B.

The segment seems relatively stable, because even though the physical portion might disappear, the digital portion still requires a physical interaction, relationships with governments, etc.

Mobile, SIMs (~30% of revenues, 25% of EBITDA)

10% of the global market share of physical SIMs, one of the top 4 global players.

This business is still recurring and has a good margin (EBITDA 20%) even though it is probably quite commoditized and competitive.

The company is moving towards eSIMs, but this represents a huge change for clients (SIMs are purchased by the network operator, and eSIMs by the phone manufacturer, with software sold to the network operator). It is unclear if the company has that much scale to compete in eSIMs.

In terms of additional SaaS-type revenues for the management of SIMs and eSIMs, it might be a source of certain protection with network operators because of switching costs and embedded technology, but it does not seem like a source of profitable growth.

In aggregate, then, a business that works today but has a Damocles sword on its head coming from the full replacement of physical SIMs.

Payments (20% of revenues, 0% EBITDA).

The original business of the company recently focused on credit card issuance in Brazil and Argentina, but before that, on all sorts of secured payment objects like bills, cheques, etc.

The business was doing ~R$200 million in EBITDA (30% of the company at the time. However, margins got really pressured from competition, mainly from Argentina's opening its trade borders.

Today, it is marginally profitable, or EBITDA breakeven. The segment is responsible for the revenue and EBIT decline between late 2023 and today. It is a sign of what can happen in other segments, mainly mobile.

Balance sheet, capital allocation, profitability, PE

Today, the company has a small net cash position (R$50/100 million), and probably a zero position when we consider debts from acquisitions (which Brazilian companies tend to classify as ‘payables’ for some reason).

Despite the net cash, the company still faces R$60/80 million in net financial expenses per year, because of non-debt interest (discounting of receivables, supplier financing, derivatives), not all cash-yielding interest (working capital uses), etc.

In terms of CAPEX/D&A, the figures are more or less similar (~R$130 million). The company says only R$50 million of that is maintenance, but given that they are building businesses, I would not count the rest as just growth, but potential future maintenance.

The company did R$440 million in EBITDA on a TTM basis, which again, seems ‘stable with risks’. From that, we remove ~R$200 million in interest and CAPEX to get to R$240 million. Up to this point, the calculation doesn’t differ from the company’s financials.

However, the company’s TTM tax rate is not sustainable. On a TTM basis, the company records a net tax credit, which is the result of JCP (see below), and other adjustments. Assuming the tax rate is indeed lower than the Brazilian corporate tax rate (25% instead of 30/35%) but is still a positive tax rate, we get to R$170 million in net income, a PE of 7.5x, not 5.5x.

Positively, the company makes heavy use of JCP (juros sobre capital proprio, interest on own capital), a way of distributing dividends that reduces its tax bill (the dividend is considered interest for tax purposes). Dividends have been close to R$100/130 million in recent years, close(r) to where I see profitability.

Read more

Screening for cheap multiples, I ran into the Brazilian real estate developers (called incorporadoras in the country). They definitely screen at very low multiples, even for forward estimates.

But being a cyclical guy, I was not going to be convinced by a low multiple alone, let alone in the mother of all cyclical industries, real estate.

Indeed, the stocks look quite cyclical, and they seem to be falling from a recent peak. It is therefore very reasonable for them to look cheap on a look-back earnings multiple basis, but still get sold off. This looked just like another cyclical top.

However, some other things caught my attention:

• The Brazilian real estate developers have performed very well between 2022 and 2025. This seems contrary to intuition, given that rates have been up in Brazil. High rates are usually poison for real estate developers.

• Similarly, the stocks of the developers are down even though, so far into late 2025, early 2026, the consensus was for lower rates in Brazil.

When we divide sector stock prices (as represented below by the $IMOB.SA index, which also includes real estate ownership) by the USDBRL exchange rate, the sector is at a recent peak but remains far from previous peaks in Brazilian real estate.

Armed with that curiosity, I analyzed the sector, and this is the resulting article.

It analyzes the drivers of the cycle, which is obviously very affected by hard-to-predict macro factors like credit and employment, by providing the granularity needed to create scenarios that are not as simple as economy good, economy bad.

Of course, I cannot know what will happen with the economy, but luckily, I don’t really need to. The article compares the companies’ market cap today (or at some point in the future if revisiting) with estimates of fair value based on operations under different scenarios, including an analysis of financial stress (key for developers) and operating leverage at different construction levels. We can use those estimates and commentary for each company specifically to speculate on what the market is pricing and whether we agree with those views.

Hope you like it!

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. At the time of publication, I do not own, but may later purchase, securities mentioned in this article.

Index

• The drivers of the real estate cycle

  • Funding and programs: MCMV, FGTS, SBPE, livre

  • Employment and cyclicality ahead

• Valuation models

  • Key warnings on construction accounting

  • Operational KPIs of the builder

  • Financing stress: acid test model

  • NAV model

  • Scenario profitability model

  • General conclusions

• Company notes and commentary

  • $CURY3, $CYRE3, $DIRR3, $TEND3, $EZTC3, $MRVE3, $MDNE3, $LAVV3, $PLPL3

• The spreadsheet for the models and the data collected can be found in the Annex to this article.

Drivers of the BR residential real estate cycle

• Credit availability is the main driver of the residential market.

• Housing credit is heavily regulated under several programs, each with different funding sources.

• How these funding sources behave end up regulating the residential cycle more than general financing conditions (like SELIC).

• 50%+ of the market is driven by the MCMV program, which obtains funds from a workers’ severance fund (FGTS). This type of credit is therefore driven above all by the aggregate employment level and worker salaries.

• Another 40% of the market is driven by the SFH program, which derives funds from poupança deposits. Because of poupança’s rate mechanism, SFH credit is inversely correlated to SELIC (contracts when SELIC goes up).

• A small by growing share of the market is fairly unregulated (credito livre). It gets funding mostly from mortgage securitized vehicles called CRI. Availability depends on general credit apettite more directly.

Like in almost any other real estate market, credit availability plays the key cycle-regulating role in the Brazilian residential market. When credit is abundant, there’s ample demand, and when it is not abundant, demand dries up.

The relationship seems pretty evident in the charts below, which compare construction employment (left-hand) with monthly mortgage credit creation (right-hand). (Note: R$1 in 2014 is about ~R$2 in 2026 due to inflation and depreciation, and therefore the two peaks of the right-hand chart are of similar inflation-adjusted value).

However, the credit market for real estate in Brazil are not tightly coupled to general financing conditions, like the reference rate SELIC, or bank lending apettite.

Rather, housing credit availability and costs move according to different government programs and home-ownership financing frameworks. These financing frameworks determine specific funding sources, where the funds should be allocated, and at what cost.

To understand the cycle we need to analyze each of these funding sources and lending programs.

Funding and programs: MCMV, FGTS, SBPE, livre

Man, once you start to analyze a regulated sector in Brazil, you get a salad of acronyms! However, fear not, it is simpler than it seems.

If we were to mix it with another cultural snippet, maybe from the Chinese love for short phrases, we could call the Brazilian residential real estate system the ‘Three sources and three programs” (三源三项).

Three sources of funds determine where the money comes from to finance the real estate credit (FGTS, SBPE, livre), and three programs determine the conditions under which credit is provided (MCMV, SFH, SFI).

Three sources

FGTS (Fundo de Garantia do Tempo de Serviço)

The FGTS is the fund that guarantees and manages the severance savings of all registered workers in Brazil. Employers pay 8% of the salary of the worker, per month, to the FGTS. When the employee is fired without just cause, for example, because the business doesn’t need the worker anymore, the FGTS pays him the severance. The worker can also get his funds if/when he retires.

The funds of the FGTS are primarily invested in real estate credit, primarily through the MCMV program. The FGTS does not retain the credit risk, which is transferred to the Caixa Econômica Federal, a state bank and the leading mortgage lender in the country (60/70% share). That is, the FGTS lends to Caixa, so that Caixa can lend to MCMV borrowers.

Because FGTS is funded from workers’ paychecks, it connects the employment market with the residential housing market. In this sense, it is incredibly procyclical: When the economy is expanding, unemployment falls, and worker salaries improve, leading to the FGTS receiving more funds, and therefore lending more to the residential market. However, when the economy shrinks and the number of workers falls, the FGTS will naturally shrink, its liquidity needs will increase, and it will therefore reduce the availability of credit, leading to a credit crunch, which worsens the economic slump.

The recent employment and salary expansion explains a large part of the boom in residential real estate of the last 3 years.

An additional challenge that the Brazilian regulators will eventually need to solve is what to do with the FGTS when the number of retiring workers is higher than the number of incoming workers.

SBPE (Sistema Brasileiro de Poupança e Empréstimo)

The SBPE system obtains its funds from a specific bank investment product called caderneta de poupança (savings book, let’s call it), aka poupança. Banks are mandated to dedicate 65% of their poupança deposits to real estate credit at mandated rates (credito direcionado).

Most modern savings products in Brazil today are tied to the CDI (the interbank rate), which is highly sensitive to the SELIC (the Central Bank reference rate).

The poupança rate follows a different scheme, which is more countercyclical and “stable”. When SELIC is above 8.5% a year, it pays less than SELIC, and when it is below 8.5%, it pays above. In addition, poupança is exempt from income taxes.

The effect is that poupança deposits expand when SELIC rates are low but contract or wane when rates are high, because people make more money on interbank-tied products.

Whereas FGTS is employment-cyclical, SBPE is rates-cyclical. In some sense, SBPE and FGTS tend to complement each other, because SBPE (poupanca) will increase with low rates, which are expected during a high-unemployment period, and will decrease during a high-rates/high-employment period, when FGTS takes the lead.

We can see this dynamic during 2020/21 when unemployment was high, and rates were low, and therefore SBPE grew (people migrated to poupança), whereas as employment and rates increased, FGTS came to the lead and SBPE shrank. Of course, a high-rate, high-unemployment period is the double-whammy of the system.

Finally, the SBPE system has recently come under reform. From 2027 onwards, the investment mandates will change. Banks will be required to have real estate credit products for 100% of their poupança deposits, but can then apply the poupança funds to whatever lending they desire. The difference in the system is a) increasing the share of poupança that goes to real estate credit; and b) separating the real estate product from the bank that generates poupança deposits.

Livre

Livre refers to any other source of funds that is not mandated to be invested in a specific real estate application.

Banks can lend to mortgage borrowers using any funds they desire, into any program/credit vehicle they desire, but of course, then the cost of credit will probably be the market cost.

The main vehicle for livre real estate credit is securitized mortgage instruments called CRI (Certificado de Recebíveis Imobiliários). CRI somewhat match the maturity structure of mortgages, and are exempt from income taxes on the interest for individuals.

Today, livre is a rather marginal portion of the residential credit market, but it is possible that it will replace part of the SBPE system as the reforms are implemented post-2027.

Three programs

The three programs or regulatory frameworks under which people can borrow to buy a house in Brazil are basically divided according to income class and property value, going from MCMV (low to middle class), SFH (middle to upper middle), and SFI (others).

MCMV (Minha Casa, Minha Vida)

MCMV is a subsidized-rate and sometimes subsidized-principal program geared towards low and middle-income families. It has existed since 2009, with a short name change (Casa Verde e Amarela) during the Bolsonaro administration. As explained above, it is mainly funded by the FGTS and managed by the Caixa Federal.

Rates can be very attractive, at 4% in the lowest range and 10% at the highest. It is divided into four segments (Faixas 1 to 4) based on the family's gross monthly income (going from as low as R$2,500 or ~$500 to R$13,000 or ~$2,500) and the price of the property (~$40/50,000 to ~$125,000). Depending on the faixa, the subsidies to rate and principal increase (lower income, higher subsidy). Given that the average salary in Brazil is R$3,700/month, MCMV covers most of the Brazilian population.

MCMV is also highly attractive for developers because the Caixa will “partner” with the developer (credito associativo) and provide funds during construction. This is obviously very helpful for developer cash-flows, which otherwise need to finance the construction themselves with equity or debt.

Given the context of a decrease in SBPE (see below), the expansion of the FGTS, and the facilities for developers and borrowers, it is unsurprising that MCMV represents the totality of the residential real estate construction segment growth between 2022 and 2025. Because of its connection with FGTS, MCMV is pro-cyclical with employment.

SFH (Sistema Financeiro da Habitação)

The SFH system is the next tier of directed credit. It can finance units up to R$2.5 million, or ~$500 thousand, which is a lot in Brazil: a middle-class, or padrão media apartment in São Paulo, can cost R$700 thousand.

The funds come primarily from the SBPE (i.e. poupança) system.

The rates are not subsidized, but capped at 12%, which is why banks need to use the poupança funds to finance this type of credit, which, under current market conditions, would otherwise have negative margins.

Of course, the average SFH loan is probably not close to R$2.5 million but rather to the MCMV ceiling of R$600/800 thousand. This segment of the population has been somewhat excluded from the attractive credit conditions of MCMV.

SFI (Sistema de Financiamento Imobiliário)

The SFI is the equivalent of the livre funding source on the lending side.

Not only can banks lend to other types of projects that are not residential, but they can also charge whatever rate they desire. As mentioned under livre, most of the financing comes from CRI instruments.

Cyclicality ahead

• Because FGTS/MCMV depends on employment and unemployment is at record lows, it is unlikely to expand as it did in 2022/25. It can either expand more moderately based on salary growth and formalization, or contract because of higher unemployment That is a neutral to negative outlook.

• SBPE/SFH and Livre/SFI depend more directly from credit conditions, of which employment is only a factor. The best scenario is lower rates that are not caused by a recession. Still, in a higher-unemployment, lower-rates scenario, this type of credit (and its middle-class, upper-class segments) could potentially do better than today.

• The worst scenario is one of recession + inflation (i.e. high-rates) like the one Brazil experimented in 2014-2018. This is obviously hard to predict but is a possibility.

To answer what will happen with credit conditions, we can think of scenarios for each of the funding sources we considered above.

Starting with FGTS/MCMV, one could argue that, with Brazil’s unemployment rate at record lows, there is simply no place to go but down, because there are no new workers. However, there are two forms in which FGTS funding can continue expanding:

• Salary growth on nominal terms, because the employer deposits are tied to the salary.

• Increase in registered workers, because unregistered workers do not contribute to FGTS. Out of the 100+ million workers above, recent studies find that up to 40 million do not contribute to Social Security (IBRE). Further, registered workers have been growing above unregistered workers for this whole cycle (IPEA).

Therefore, the FGTS/MCMV system can continue growing even with a flat occupied population.

This year, the perspective is for credit to continue growing, ~10%, but this is heavily driven by the election year. Policies tending to higher credit include the funding approved for MCMV, allowing Caixa to relax LTV standards, and reforming the SBPE system.

Going forward, the government plans have approved a stable funding level for MCMV from the FGTS into 2029, but obviously, these plans can change with the economy and with a new government.

Another key question, even with a Lula victory in 2026, is whether the government will decide to cool the economy a little in 2027/28, in the first years of the new government, when political capital is high.

Of course, the largest risk is an increase in formal unemployment coming from a recession. Previewing the length and degree of such a recession is kind of futile.

Where I stand in terms of risk/reward is a position of neutrality to slight negativity. We are obviously not at a cyclical bottom with record unemployment, and the best scenario is one of stable growth, not explosive growth as we saw so far. The risk of a prolonged recession is hard to predict but very real, and a new government (even if the same president or party) will probably have the political capital to cool the economy a little.

The remaining credit market of SBPE/SFH and CRI/SFI depends more on credit conditions. Employment is also important but only as a factor in credit conditions, like SELIC or credit apettite.

The best scenario is one of lower rates, where poupança is more attractive, and livre financing costs are lower, but which is not caused by a recession.

In the mid-scenario of higher unemployment but lower rates, we could have a K-shaped market, where the middle and upper classes can access credit because their creditworthiness is not affected and banks look for relatively less risky investments, therefore making funds are more available. In fact, this is what happened in 2017-2021, with SFH/SFI being the driving force of the market expansion from a recessive period.

The 2014-2018 double-whammy

The worst scenario is, of course, an inflationary (high-rate) recession, which is what Brazil got in 2014-2018.

At the time, the economy had been growing, but heating (World Bank, World Bank), in part because the BRL was depreciating (USDBRL went from R$1.5 in September 2011 to R$4 in September 2015). The Central Bank started hiking in 2012, going from ~7.5% to 10% in 2014 (SELIC historicals).

By 2014, the economy had already stopped growing, but because the country experienced depreciation and inflation between 2011 and 2016, the CB continued increasing rates into 14% by late 2016. Only then, with 2x the unemployment rate (World Bank), did the Central Bank cut rates, after two years of recession.

Under this scenario, credit concessions to real estate were halved in nominal terms, and probably cut by 70% in real terms from their peak.

Could this scenario repeat? Yes of course, mainly via a capital flight or balance of payments crisis leading to persistent depreciation and inflation. The 2014-2018, however, seems like a complete coctail: commodity prices collapsing, capital flight, political chaos, austerity, inflation, high-rates, etc. It is very hard to predict another crisis like this, but it has to be kept as a possibility, and ask for a return accordingly.

As a side note, an aggravating factor at the time which is not as present today is that, back then, a large part of MCMV came not from FGTS but from the Federal budget (Orcamento Geral da União, OGU below). That budget was cut with the austerity measures implemented in the second half of the Rousseff government and during the Temer and Bolsonaro governments. Today, funding comes almost exclusively from the FGTS.

Furthermore, even during the 2014-2018 period, though their operations shrank significantly, the currently public companies remained EBIT profitable, and did not suffer significant impairments or equity challenges.

Valuation models

Of course, I cannot know what will happen with the economy, but luckily, I don’t really need to. We can compare each company’s market cap today (or at some point in the future when revisiting) with estimates of fair value based on operations under different scenarios.

This section includes models for analyzing financial stress (key for real estate developers), NAV, and operating leverage at different construction levels, along with commentary about company-specific factors like segment exposures, balance sheet structuring, and historical analysis.

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This Annex to the Brazilian Real Estate Developers article provides the file containing the models used in the original article, and the data used to build the models, plus notes on methodological decisions.

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The last post in the blog covered the cyclical situation of the Brazilian meatpackers. Because two of the three meatpackers have substantial operations in…

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The Brazilian meatpackers are a very interesting industry.

One of the clearest examples of multinational giants that call Brazil home and have a relatively strong global position, these companies built global platforms in meat processing based on the competitiveness of the Brazilian soil. Starting with Brazilian cattle, they expanded into other geographies and proteins via acquisitions during cyclical downturns. Today, Brazil ranks first in global beef and chicken exports, and third in pork.

Meatpackers enjoy secular tailwinds, as developed and developing countries alike seem to have an insatiable hunger for protein, a food considered healthier every day.

Because of barriers to entry in export markets, the meatpackers can absorb a large share of Brazil's competitiveness when animal supply is plentiful.

For the past three years, the margins of the meatpackers have expanded thanks to climbing protein prices coupled with stagnant or falling grain prices. The Brazilian cattle herd cycle has been positive for Brazilian exports at the same time as US herds reach minimums. This has helped their stock prices in the cases of JBS and MBRF (Minerva underwent its own leverage and acquisition integration challenges).

However, cycles never last forever. Brazil’s cattle herd is expected to decline, grain prices are climbing because of the Hormuz situation, and Asian markets might be hit by the economic impact of the war and currency depreciation. This situation finds some of these companies pretty levered, and paying BRL interest rates that are above their returns on capital.

In this overview, I revisit previous works on the meatpackers and add analysis for the cycles of the future.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

Index

• Meatpacking industry basics

• Brazilian meatpackers basics

• Deeper market context

  • Beef

    • US

    • Brazil

  • Swine

    • US

    • Brazil

  • Poultry

    • US

    • Brazil

• Near-term cycle factors

  • Asian and Gulf demand

  • Grain prices

  • BRL exchange rate

  • Domestic demand cycles

• Adding all together: summary by company and segment, plus valuation comments

• Premier Annex: The Premier Annex to this article contains a deeper dive into the assets of each of the meatpackers by geography, segment, and link in the value chain. It also contains the data references and sources to follow the cycle forward.

Other articles on the topic

Meatpacking industry basics

Aggregator network

The meatpacker is the aggregator of the animal industry into the meat industry.

At the core, a meatpacker is a company that buys live animals (cattle, poultry, swine) and transforms them into marketable meat products. This process happens primarily in a slaughterhouse. In the case of poultry and a little less for swine, meatpackers also integrate upstream into animal husbandry.

Their existence in the value chain is necessary because both the live animals market and the consumption markets are highly atomized. In addition, live animals do not usually travel long distances, and meat products have very strict sanitary regulations, with permissions for export at the slaughterhouse level. The slaughterhouse is therefore a point of access for a local animal market into the global meat consumption market.

The meatpacker builds a network of slaughterhouses, each with regulatory and reputational access to different domestic and global markets for consumption, and also to different animal supply markets. In the arbitrage between local animal prices and the different consumption markets’ prices for meat products, the meatpacker makes a margin, as measured by the difference between the price of the live animal (or the cost to raise an animal to slaughter weight in the case of upstream integration) and the value that can be obtained from its parts in the destination markets (of course, adding the labor, manufacturing, taxes, and transportation costs to bring the product to market).

Cycle drivers and network scale

The cycle of the meatpacker is protein-dependent (i.e., type of animal) and geography-dependent. That is, we talk about the cycle in Brazilian beef, Australian lamb, or US poultry. We could even bring the detail to regions within large producing countries. The cycle is determined by the availability of supply (number of animals), the processing capacity (measured in animal heads per day), and the demand/supply situation in the markets of destination of that particular region/slaughterhouse.

The best situation for a meatpacker is to be in a region where animals are plentiful, slaughterhouse capacity is fully utilized, and destination markets are supply-constrained. In such a context, the meatpacker can make the best margin. The opposite situation is having shortages of animals, idle slaughterhouse capacity, and depressed demand or oversupplied end-markets.

Because of the above, meatpacking is a business with a network scale. A meatpacker in a single region or with access to a few markets has a very volatile cycle. Therefore, when the cycle is bad in that region, he might get acquired by a larger player making money in another region. This is why meatpacking has slowly turned into a form of oligopoly/oligopsony. Oligopoly, because a few companies dominate the global demand markets, and oligopsony, because in any given region, only a few meatpackers have slaughterhouses to which a producer can sell.

Demand-side

The demand side of the cycle in each of the destination markets is influenced most heavily by income, although the degree of discretionary/defensive varies with each type of protein and the base level of wealth in each country. In the US, poultry might be defensive, but it’s probably more discretionary in Southeast Asia.

Secularly, protein in general is a highly sought-after product, and it is not reaching a saturation point, even in advanced economies. Meat consumption grows super-linearly with GDP in developing economies, but still grows in developed economies too. Peppered in this secular growth trend are cycles driven mainly by discretionary income and by protein prices (highly affected by grain prices).

Animal supply cycle: herd cycle, capital, and climate

The animal supply side of the cycle is different for each species, but in general, it is largely driven by three factors: the animal stock (herd/flock) cycle, the capital cycle (housing, fairly relevant for poultry/swine mainly), and the feed cycle (grains like corn or soybeans, or pasture/hay).

The producer makes a margin between the cost to feed the animal to slaughter age/weight and its price in the market alive in the slaughterhouse. There are other relevant costs like medicine, labor, lighting, heating, water, etc., but feed is the most important, reaching up to 70% of costs for poultry/swine.

When the aggregate stock of animals in a region is low relative to demand, the margin for the producer is good. The producer then decides to increase his stock. Conversely, when margins are bad, the producer wants to reduce his stock of animals.

How this increase happens depends on animal biology and affects the length of the supply cycles in each protein type (animal). The longer the lifecycle of an animal, and the longer the reproductive cycle of the animal, the longer and more volatile the animal stock cycle.

For cattle, the cycle is more relevant, lengthy, and violent. Cattle inventories take a long time to build because a cow can only have 1 offspring per year, and requires about 1.5 years before being able to have offspring. When animal supplies are low, producers might decide to sell the calves before they can have offspring, hindering the growth of the herd. The aggregate inventory of cattle decisions has to look 3/4 years in advance.

For swine, the key decision is how many females (sows) to put through pregnancy per season (2 seasons per year). This process is called farrowing. Each pregnant sow can have up to 12 pigglets (called a litter). Depending on that decision, the producer will have a specific pig crop per season, which can be fattened and then slaughtered. The decision is taken with 6 months of look-ahead. If the producer wants to increase his pig crop, he can retain some of the female piglets (called gilts) for about 6/8 months before they are ready to increase production. Further, one additional sow increases the yearly production by up to 20/25 animals. Therefore, the biological cycle is much shorter and much less relevant, as a constraint in capacity, than it is for cattle.

For poultry, the decision-maker (usually the meatpacker, upstream integrated) determines how many meat chickens (called broilers) to provide to a grower (a figure called broiler placement). The grower receives all inputs and puts labor and management under contract to bring the birds to slaughter weight. Within a few weeks, that cycle is finished. In order to increase the flock, the producer can simply place more broilers, obviously depending on housing capacity. Eventually, this will require having more breeders that lay fertile eggs, but again, the process from female increase to animal multiplication is fast because a breeder can generate as many as 150 chicks per year.

The animal stock cycle, therefore, exacerbates the supply cycle. When animals are scarce, they are most valuable as breeders, and therefore breeding decisions further reduce the availability of animals in the market for slaughter. When animals are plentiful, margins are low, and producers want to get rid of their stock, putting even more pressure on live-animal prices.

Notice the difference, however. For a cattle cow-calf producer to increase his calf crop by 1 per year, he has to spare 1 animal today from sale. A swine producer can increase his crop by 20 per year by sparing 1 female. A poultry producer has a 150x multiple on 1 female (which is actually not spared from the flock but rather bought from a different species).

In the case of poultry and swine, capital plays a larger role than the animal cycle. The animals require housing, and the decision to build housing is both more long-lived an harder to reverse than how many animals to house once it is built. Still, capital costs are not nearly as relevant to production as variable feed costs.

In the case of cattle, capital may not be as relevant, but land is, particularly for specific segments of production (cow-calf producers and early feeder producers) that require pasture or hay to eat. A big part of the current cycle in North American beef can be explained by land access and conditions.

Finally, the animal supply cycle is highly influenced by the cost and availability of feed, basically grains like corn and soybean for swine, poultry, and feedlot cattle, and pasture or hay for pasture cattle.

When grains are more expensive, protein is more expensive for the producer, and generally as well for the consumer. This impacts demand and generally pressures margins to the downside. Low grain prices are positive for the protein value chain in general. Even when they are high, accessing sufficient grain is generally not a problem, given that these are globally traded commodities and that the producer countries we are considering here have exportable surpluses.

Pasture or hay availability is relevant only for cattle production. Even in high feedlot-integrated systems like the US, calves and young adults usually need pasture or hay. Pasture and hay are much more influenced by climatic conditions, which can render them insufficient, therefore capping the size of the herd. Pasture and hay also compete for land with other, usually more capital-intensive uses of land, like grain crops.

Meatpacking capacity

A final component of the cycle is how much capacity for processing live animals and turning them into meat is available in a given region, compared to the supply of animals in that region.

This is particularly true for cattle and swine, where the packer might not be integrated upstream in the animal supply decision (like the case of poultry).

If, because of climatic, feed cost, or capital shortage reasons, there are too few animals to keep the capacity of a plant operating, the meatpackers will bid up the price of the animals, eating into their own margin. These plants have a skilled and numerous workforce that puts pressure on operating leverage, and generally have large capital layouts (asset utilization is close to 1x in these businesses).

Upstream integration

The meatpackers integrate the upstream producing link in the animal supply chain, particularly into poultry and swine.

The model is generally one of exclusive contractors. The packer provides the animal shortly after birth, the feed, and sometimes even covers other costs like medicine, and pays a fee for managing the feeding process until slaughter capacity. This is particularly true for poultry.

In other, less integrated models, the packer might still sign price contracts to provide safety to the producer, but might not provide the working capital, or carry the full margin risk.

Cattle producers are generally not integrated, or only moderately so. Cattle require high working capital outlays that are quite illiquid for up to a few years. Margin risk is pretty high. The meatpackers have generally shunned this link in the chain.

Downstream integration

Downstream integration is very prevalent among meatpackers.

Both JBS and MBRF have consumer brands in beef, poultry, and swine. This allows them to negotiate from a stronger position with retailers and distributors, given that consumers can place some value on the brands.

In the case of poultry and swine, particularly poultry, both companies also have large processed products brands and operations. This includes breaded chicken, hamburgers, ham, bacon, seasoned or value-added cuts, and sausages. In some consumer markets, like the US poultry industry, processed products make up the majority of the consumption of meat.

Downstream processing makes a lot of sense because it can capture the much better margins of building consumer brands, it can leverage the size and cost advantage of the meatpacker in segmented geographical consumer markets, and it is another way to diversify the risk of any specific protein and geographic cycle.

The Brazilian meatpackers

Today, there are three publicly traded Brazilian meatpackers: JBS, MBRF (the merger of Marfrig and BRF in 2025), and Minerva.

Each of them is about 3x larger than the other. Minerva has ~$10 billion in revenues, MBRF ~$30 billion, and JBS close to $90 billion.

Naturally, the largest players are more diversified, with JBS spanning all large protein groups along global geographies, and Minerva concentrated almost exclusively on cattle in South America.

Below are tables comparing their revenues and EBITDA by segment.

JBS is the largest, most diversified, and I would argue, strongest and highest-quality company in the group. They have a substantial operation in the US, representing more than half their revenues and half their EBITDA, across the three main proteins. In most of their segments, they have strong upstream and downstream integration. Their balance sheet position is the strongest, with most of its debt in USD, at fixed rates, and with long maturities.

MBRF follows very closely. The company is very strong in Brazil's poultry/swine markets through its Sadia and Perdigao brands. Their exposure in the North American beef market is almost as large as JBS's. In South American beef, they used to be a larger operator but sold a large part of their Brazilian, Uruguayan, and Argentinian operations to Minerva. Their balance sheet is not as pristine. They are fairly levered, with high exposure to BRL debt, which is expensive.

Finally, Minerva is a pure-play South American beef player, with approximately 60/70% of its capacity in Brazil. It is smaller and the most leveraged of the three.

Market context

Now that we have a basic understanding of where the companies operate and how a meatpacker makes money in each of the main protein markets, let us analyze the situation in each market, both by protein and by geography.

As a 30 thousand feet introduction, let us compare the FAO Meat and Feed price indexes for the past decade. We can easily observe how the 2020-2023 period of pressured margins (higher feed, slower meat) has been followed by a great period for meat, with falling feed prices and climbing meat prices. This is the context in which we find the industry today, a good profitability period across proteins and geographies (except US beef packing).

Beef

Beef is the most cyclical of the three proteins because of the compounded volatility of the herd cycle, the local pasture cycle, and the discretionary income cycle.

For the companies in this review, the two most important markets are the US and Brazil. In both geographies, the domestic market represents the majority of revenues, but exports are also a big consideration in the Brazilian cycle.

The US cycle has been a headache for meatpackers for a long time, already close to 5 or 6 years in a downcycle. It does not seem to be turning positive just yet. Capacity rationalization at the packer level might be needed.

At the same time, the Brazilian cycle, which had been a fantastic deliverer of profits and which still retains secular tailwinds, is starting to turn into a downcycle. Beef will be one of the tough spots for the meatpackers in 2026/27.

US

• Secularly, the US is the largest producer and consumer market, but beef production has not grown since 1995. Structural conditions prevent this, including the cost of opportunity of pasture land, and potentially climate change.

• Cyclically, the current herd downcycle has lasted 5 to 6 years, with minimal animal supply availability. Meatpacker capacity utilization has fallen by 15% since 2021/22, and meatpackers are operating at EBITDA breakeven levels or worse.

• There are only a few cyclical indications of a herd inventory recovery cycle, and, secularly, doubts over the long-term beef-producing capacity in the US are still relevant.

• A recovery in profitability will probably require meaningful capacity reductions.

The US is the largest producer of beef in the world (closely followed by Brazil).

It is by far the largest consumer market (~13 million tons per year), even larger than China’s (~11.5 million tons). It is therefore no surprise that US beef represents one of the largest segments for both JBS and MBRF.

The US market is predominantly domestic. Production covers about 90% of consumption, and the country is a net importer, but not by a huge amount. Therefore, the determinant of the cycle is primarily the local herd and the local demand circumstances.

In terms of herd, the US has been in a prolonged negative cycle since at least the pandemic (left-hand side chart below), which, when seen from the perspective of history (right-hand side chart below), can even be considered secular. Cyclically or not, the US beef production has been basically flat since 1995.

There are several reasons for the US herd to shrink.

Secularly, other more intensive uses for land have become more profitable, especially agriculture, replacing pastures, thanks to the green revolution. The introduction of the feedlot as a link in the value chain allowed to produce more meat with the same or fewer animals. The productivity per animal in the US is twice or more than that of Brazil.

Cyclically, droughts in the US deteriorated pasture conditions in the Plains, where most of the cow-calf industry is based. The link in the chain that produces calves (called a cow-calf producer) is the most dependent on pasture conditions. When pastures are in worse condition, they can sustain fewer animals, leading to a lower intention to keep females to enlarge the herd next year.

In addition, the demand boom for meat during the pandemic led the next stage of the chain (called the feeders) to have a significant demand for calves. This stage buys a calf (female or male) from the cow-calf producer, and then feeds it (a mix of pasture and grains) until it is ready for slaughter. When demand for meat is high, and (as has been the case since 2023) grain prices are low, margins for feeders are high, meaning they are willing to pay up for calves. This leads to cow-calf producers having even a larger incentive to sell their calves before they can reproduce.

Today, there are still no signs that the herd cycle is turning, leading to continued supply tightening, at least as expected by the USDA.

We can observe that pasture conditions as an aggregate in the US have been significantly better in the past three years compared to 2020/21, but still almost 20pp below where the cattle cycle found its previous peak in 2015-2020.

On top of the cattle cycle, we also have capacity in the US beef packing industry, measured in slaughter head capacity per day, also called shackle space.

There is no aggregate US measure I was able to find.

However, the USDA reports for Federally Inspected Facilities show that the aggregate number of facilities has grown by 40% since 2019, and yet the slaughtered animal count has fallen by 12% since 2025. This speaks of idle capacity.

The increase in facilities (by number, not capacity) has occurred primarily among small plants of less than 10,000 heads per year, which grew 45% in that period. The animals processed in those plants also increased in line, around 48%. Still, as an aggregate, the segment represents less than 3% of the market. The increment could also represent simply a change in inspection (from state to federal).

The big losers of animal supply have been the large plants. For the facilities above 500 thousand heads per year, which represent 65% of the market, and which are probably the ones with the highest overhead costs to dilute, slaughter figures fell by 20%+. They lost more cattle (about 5 million animals) than the whole market (3.5 million animals). The number of facilities fell by a similar figure, from 22 to 18, or 18%.

Finally, in terms of demand, the US remains insatiable. Despite the price of beef climbing by 85% since late 2020, consumption has expanded by almost 6% in aggregate terms. Because the production of meat has fallen by almost 10% in the same period, higher net imports have occupied part of that space.

In conclusion, at least until 1Q26, the American consumer keeps demanding beef and pushing the price upwards, but the economics of cow-calf production have not yet reached a point where the herd is expected to grow and eventually recover the domestic supply of beef. In the meantime, with a low supply of animals and record capacity, meatpackers earn basically loss-making margins.

Because of the secular reasons pushing for a smaller herd, and the fact that cyclically, the herd does not seem to be close to turning yet, it seems that the only potential cyclical recovery will come from further plant closures.

Brazil

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Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

This Annex to the Brazilian Meatpackers Update article provides a table detailing the capacities and assets of each of the meatpackers in each of their segments and accross the different stages of the value chain (upstream, slaughter/processing, downstream/consumer), and a list of key references to follow the cycles in the Brazil, the US and globally.

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Continuing the analysis of Forest Industries from my last article (Forest Industries I: Basics), this article dives a little deeper into the wood products industry in North America.

North America (mainly the US) is one of the largest consumers and producers of wood products (lumber, plywood, OSB, engineered wood). An abundance of forests in the US South, and the Pacific West determines the competitive locations of these industries.

The industry is highly cyclical, both because of its own supply determinants, but also because a majority of its demand comes from construction activity (mainly single-family wood-frame housing), itself a highly cyclical industry.

Today, the industry is undergoing its worst, deepest, and longest downcycle. In many measures (length, capacity underutilization, margins) it is worse than the GFC. Half the companies in the industry are close to or below breakeven EBITDA. These same companies were making money hand over fist in 2021 and 2022.

However, some companies are not so pressured, either because they participate in higher-value subindustries or because they are more diversified into several segments. These companies are well prepared to survive the downcycle, and may emerge as the winners of a recovery, coming either from a reduction in supply or a recovery in housing activity in the US.

This article reviews the characteristics of the wood products in general, in North America in particular, to then analyze each of the public companies participating.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

Index

• The Industry

  • Reviews of the basics

  • Forest basins in North America

    • Canadian tariffs

  • The market in the US

  • The wood industry and construction after the GFC

    • New construction

    • Repair and remodelling

    • Other uses

    • Aggregate demand

    • Annex: changes in construction trends

  • Capacity, utilization, and margins

    • Historical capacity

    • Historical margins

• [PAYWALL]

• Companies

  • Weyerhaeuser (WY)

  • Rayonier + PotlatchDeltic (RYN)

  • Louisiana-Pacific Corp (LPX)

  • West Fraser Timber (WFG)

  • Boise Cascade (BCC)

  • Canfor (CFP.TO)

  • Interfor (IFP.TO)

  • Western Forest Products (WEF.TO)

  • GreenFirst Forest Products (GFP.TO)

Annex

The Premier Annex to the North American Wood Products article provides access to the Excel files for modelling the largest companies analyzed and summarizing their capital allocation and performance history, along with summary reviews of all companies in concise Excel and PDF formats.

The Annex also explores changes in US housing construction trends to establish whether these could represent a risk for demand for the North American wood industry.

• Data package

• Construction trends in the US

Other articles on the Forest Industries

The industry

Review of the basics

Let’s start by reviewing some aspects of the wood products industry, key to understanding its economics and cycle. Then we can add more data on North America specifically. This is only a short summary. I highly recommend you read the complete section in the Forest Industries Basics article.

• Wood products are the largest consumer of wood globally. The industry also consumes the highest quality wood, and it is key for the generation of co-products used in other industries (like pulp).

• Wood product demand is highly tied to construction, particularly in North America and Europe. In other areas (particularly China as an exporter), wood product demand is tied to decorative, furniture, and cabinetry functions. Specifically for the North American case, about two-thirds of wood product demand comes directly from residential (especially single-family) construction, both new construction and repair and remodelling (R&R).

• One way to distinguish wood products is between structural and panel functions. Structural products need to bear a load in construction or furniture. In contrast, panel products do not generally need significant strength; their function is filling, insulation, or decoration.

• Another classification is between lumber products (solid pieces of wood), veneer products (laminates either alone or reglued for higher strength), composites (particles, strands, or fibers reglued together, like OSB, MDF), and engineered wood products (pieces of wood glued for higher strength, like LVL, glulam, mass timber).
  In general, lumber and engineered wood products cover more structural functions, whereas veneer and composites are used in panel functions. In addition, lumber products depend more on log quality (and therefore wood is a higher cost component), whereas veneer/composites have a higher manufacturing cost component.

• Wood products are regionally and even globally traded much more than both raw logs and paper. The competitive regions are based on forest resources, particularly for lumber/solid wood products. In engineered and composite products, industrial capacity is more relevant, but access to raw material sources is still important.

• The scale of manufacturing facilities plays a larger role in composite products where non-wood costs are more relevant. In solid wood products, scale has to be traded off with logistic costs from log obtaining and transportation.

Forest basins in North America

North America, as a subcontinent, has three main heavily forested (and economically harvested) regions where most wood comes from:

• the Northern Pacific Coast, covering Oregon, Washington, plus northern California in the US, and the Canadian provinces of British Columbia and partially Alberta.

• The US Southeast, going from Eastern Texas to the Carolinas and Virginia.

• The Northeast, which on the US side includes the Northeast Coast, the lakes region, and in Canada includes Ontario and Quebec.

Historically, the Northwest of the continent provided a large part of the production, but since at least the GFC, the totality of the increment in continental production has been provided by the US Southeast.

Today, the US Southeast is the most competitive region in terms of fiber for the majority of forest industries. As explained in the Forest Basics article, temperate regions (like the US South) have, ceteris paribus, higher biological forest productivity (trees grow much faster). Further, although the US South uses natural forest systems, it is increasingly a plantation system region, with the associated productivity benefits described in the Basics article. In contrast, the Western and Northern regions are entirely natural forest systems. Finally, the US South region is much closer (actually within) the areas where the US population has been growing the most, like Texas, Florida, and the Carolinas, and therefore where the most wood is needed for construction.

To the above, we have to add natural factors, like the increasingly recurrent droughts and fires in the US Pacific, and beetle infestations in British Columbia, which have reduced the availability (or increased the cost of harvest) of logs. The effect of tariffs (established in 2018 and discussed below) is also evident in the fall of Canadian production, especially in British Columbia.

In more commoditized, lower log-quality applications, which include most dimensional lumber, plywood, and composites, the US South is displacing the Western regions. The West is increasingly only competitive in export markets in Eastern Asia (mainly Japan and China) for very high-value logs from local species (Douglas fir, western hemlock), which are sold as timbers, decorative veneer logs, high quality dimensional lumber, etc.

Canadian tariffs

Canadian production is also affected by heavy tariffs in the US, and has been so for almost 10 years. The US has consistently argued that the harvest (stumpage) system in Canada, which is based mostly on public (Crown) owned land, is an unfair subsidy to lumber and timber production in Canada versus the mostly private land system in the US.

Since 2018, the US has applied anti-dumping (against selling below a minimum price) and countervailing (against subsidies) duties to Canadian exporters, which are determined by mill/basin, and reviewed every few years. On top of that, the Trade War 2.0 tariffs added 10% flat rates on lumber and timber in 2025. The combined rates depend on each producer, but range from about 25% to as much as 45%.

The duties are paid based on the then-current rate but are applied retroactively to previous production after the next duties review. Therefore, many Canadian companies record an asset (most of the time) or a liability based on what they believe they are entitled to receive or required to pay, compared to their cash-based duties.

An important note is that most engineered products (plywood, OSB, LVL, etc.) are not covered by the duties, but are covered by the additional 10% rates of the Trade War 2.0 tariffs. Even when not covered, these products remain at a disadvantage versus the US because of their dependence on the Canadian forest basin.

The market in the US

We can basically speak of a unified North American market between the US and Canada, with the former being the single demand source for both.

Canada is a relevant producer of both sawn wood and wood panels (left-side charts), but it is not a relevant consumer (right-side charts).

Canada exports more than 60% of its production of sawn wood and wood panels (blue lines). The US, in contrast, is an importer market for both types of products (light blue lines), and doesn’t export a large part of its production (green lines).

When we compare Canada’s export markets (graphs on the right side below) and the US import suppliers (graphs on the left side below), we find that accross all products, the US is almost the only market for Canadian products, with a small exception for sawn wood; whereas the US has a more diversified import supplier base, with more weight in Asia, LatAm.

The wood industry and construction after the GFC

As mentioned, most wood demand comes from construction, at least 66% directly (USFS, 2019). The enormous majority of its is single-family and repair and remodelling.

New construction

On the demand side, the most volatile cycle driver is housing starts. Housing activity shows a strong correlation with both the production level and the relative change in capacity utilization in the wood industry.

We can observe how, after a period of high cyclicality between 1960 and 1990, housing climbed almost uninterrupted between the early 90s and 2006, along with wood demand. The GFC was a catastrophic collapse in housing starts, 75% fall from the peak in 2006 to the bottom in late 2009. Wood production halved in that period as well.

The post-GFC period was a slow recovery, similar to the 90s in its lack of cyclicality. This was interrupted by the pandemic and the current high-interest-rate period. We can observe how current levels of housing starts do not seem far out of line with the historical average in the US, but are still fairly depressed when compared to the late 1990s, early 2000s period. Wood consumption is also similar to that period.

Repair and remodelling

The second half of demand is repair and remodelling. Although new housing is twice as large as remodelling in dollar terms (first chart below), both consume about the same amount of wood materials. Both are correlated but more cyclical than real GDP (third chart below).

Remodelling did not fall as much after the GFC, and has continued growing after COVID, even as new construction stalled (second chart below). The reasons for this divergence between remodelling and new construction seem to be the lack of affordability for new buyers, homeowners preferring to stay in their houses to lock in lower interest rates, and a population that is growing more slowly.

Other uses

Besides construction, other important uses of wood include:

• Packaging and shipping, overwhelmingly pallets, is a large consumer of commodity lumber (~18/20 million m3). It is a relatively low-cyclicality sector that moves with real GDP.

• Furniture, including cabinetry, consumes a mix of lumber and non-structural panels like MDF, about 3 million m3 each. Furniture is naturally a more discretionary category, but it is also secularly impacted by the US desindustrialization after the 2000s.

• Out of the ‘other’ industries, the most important is utility poles, which is a standalone category of wood products.

Aggregate demand

Adding all together, we definitely cannot talk of a growing wood industry in the US (and by extension, North America). Consumption levels are basically similar to those of the late 1980s, and the industry has not grown since 2015.

The industries that demand wood move along with real GDP, but there could be step changes caused by modifications in consumption or production patterns.

First, obviously, is new construction.

The wood market bulls will always mention an upcoming new build cycle as the stock of housing in the US ages and the ‘big wealth transition’ from boomers to millennials occurs. This could very well be, especially with the right credit and political conditions. A construction boom would be a secular tailwind for wood demand.

On the other hand, construction can also become a headwind if consumption patterns shift to smaller multi-family houses, a topic discussed in more detail in the Annex.

Without a boom or a change in consumption patterns, construction will still grow, albeit probably more slowly than GDP. The number of single-family units built is the same as in 1995, but their size and wood consumption per unit have increased 20%. Of course, this is not much when compared with 80% higher real GDP (in 2019), but we could still be suffering from the GFC lags.

In the case of remodelling, we have already observed that even though expenditure in remodelling is still strong, and grows above GDP over the long-term, it does not carry more consumption. Similar to new housing, although remodelling expenditures are up 130% in inflation-adjusted dollars since 1995, wood consumption is only up 20%. The total occupied housing stock seems to be more related to this driver.

Finally, we have manufacturing as a potentially small growth engine if either manufacturing is reshored within the US (for example, in the historical furniture states of the Southeast) or near-shored to Mexico, but still consuming mostly US South wood products. In both cases, however, I do not think that reindustrialization can be a huge driver, given the current size of manufacturing and other sectors in current consumption.

Capacity, utilization, and margins

The other side of the cyclical equation in wood is obviously supply, or rather, capacity.

During the 1990s and until the GFC, capacity expanded in line with an increasing construction industry and aggregate wood consumption. This kept capacity utilization at what can be considered fairly competitive and pressuring levels, only hovering above 80%, for most of that period.

The 1990s and early 2000s were a period of huge expansion in wood consumption, but capacity expanded in line with it. This tells us a lot about the long-term dynamics of the industry. It is hard to achieve capacity utilization even with a growing market.

The period after the GFC has been significantly more challenging. Capacity utilization quickly reached 50% during the GFC. Pain was probably significant because it triggered a large curtailment. In three years, the industry lost 25% of its capacity. By 2015, capacity utilization reached 70% again, and it is probable that more than half of that was curtailments, with the remaining being demand recovery.

Still, considering that capacity utilization has remained below 80% except for a small period around the pandemic, and that wood consumption fell 50% from the GFC and never recovered even half of that level (that is, even today it is 25% below of the GFC), the degree of curtailment is too low to recover profitability.

Even more, although during most of the 2010s, capacity additions were fairly constrained in aggregate, a small period of higher profitability in the mid-2010s quickly led to a new wave of capacity additions.

Finally, when utilization improved above 80% during the post-pandemic demand boom, and as we will see below, and wood producers enjoyed record margins, capacity additions appeared again very quickly.

From an industrial perspective, this is not a good sign. The curtailment was slow, small in relative terms, and utilization (and consequently margins) has been permanently impaired since. As soon as margins improved, capacity was added fast and aggressively.

Historical margins

We can get an idea of margin compression/expansion during the 2000-2020 period by comparing producer price indexes in the US for logs (solid blue line below) with the producer price indexes for processed wood products like lumber, plywood, or reconstituted wood (dotted lines).

The 1990s were not marked by margin expansion. If anything, by pressure. Log prices climbed at the beginning of the period, and downstream products grew only moderately more. Again, low aggregate utilization and capacity additions accompany the expanding demand.

The inter-recession period of the early 2000s had a huge margin expansion, coincident with the peak of the housing bubble. If we go back to the capacity chart at the start of this section, we see how it rapidly led to capacity expansion.

The 2010s see a recovery in margins, as capacity utilization consistently improves. Again, the sprouts of better margins in 2014/15 led to capacity additions quickly. The 2017/2019 is probably the outlier here. It coincides with the start of the collapse of the Canadian BC wood industry.

After COVID, the combination of stimulus policies led to exploding margins. The profits in this period are absolutely record-breaking, and will be hard to repeat in the future, given that they were the combination of immense demand with relatively tight supply.

The exorbitant profits led to a new wave of capacity additions, which, combined with lower construction activity because of higher rates, led to a new low in utilization and depressed margins yet again.

The last chart above does not fully capture the margin situation of wood producers today. With the exception of the GFC, capacity utilization in the US wood products industry has never been as low as it is currently, and producers are feeling it, with most of them not making adjusted EBITDA profits in sawmilling in 2024 or 2025.

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Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

This Annex to the North American Wood Products article provides access to the Excel files for modelling the largest companies analyzed and summarizing their capital allocation and performance history. It also provides summary PDFs and powerpoints of the article.

The Annex also explores changes in US housing construction trends to establish whether these could represent a risk for demand for the North American wood industry.

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After every quarter, I provide a review of the performance and positions of my two personal accounts (IBKR and Argentina). I think this provides r…

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The Forest Industries are a long value chain, extending from natural and planted forests through processed wood materials vital for construction and furniture, and through pulps that become everyday paper and packaging.

The cycles of the Forest Industries are driven by geographical and economic factors like availability and cost of raw materials, through capital and processing capacity, and finally end-demand drivers, like construction, e-commerce, or CPG retailing. Some links in the chain compete very locally, while others are global.

In recent years, different links of the value chain across geographies have been under high cost and margin pressure. Common traits of these pressured cycles are high raw material costs and supply shortages, excess capacity buildup, and ailing end-demand.

Like with many other cyclical industries, the end goal of this analysis is to try to find low-cost, underlevered players, trading at attractive multiples of estimated cycle-average earnings.

Given that the majority of the players in the industry span several links of the value chain, this article tries to provide an overview of each link, how it is distributed globally, competitive drivers, and the recent cyclical situation.

This will come in handy when evaluating the companies in future deliveries.

Without further ado, chop chop chop!

Index

• A map of the value chain

• 1. Forestry globally

  • a - Types of wood and wood qualities

  • b - Types of forests

  • c- Productivity of forests

  • d- Trade

  • e- Challenges in supply and elasticity

  • Why not South American softwood?

  • Oil shortage impacts

• 2. Wood products

  • a - Product types and uses

  • b - Trades

  • c - Scale

  • d - Cyclical position

• 3. Pulp and paper

  • a - Mini-review of virgin pulp (aka chemical pulp)

  • b - Recycled pulp

  • c - Paper types

  • d Trade

  • e - Scale and specialization

  • f - Cyclical position

A map of the value chain

The schematic above shows most of the value chain of forest products and the industries reviewed in this article.

As we can see, it includes four main industries:

• Forestry: wood obviously comes from trees in forests. Some of those forests are specifically planted for wood harvesting, whereas others are natural forests from which a sustainable level of wood is harvested each year. Forestry is the basis of competitiveness in downstream industries because of the weight of fiber costs in overall product costs, and because 'raw’ wood is expensive to move around.

• Wood products: These are what we would usually think of as a wood product, going from a piece of lumber used for structural purposes in construction, to the composite material inside and the veneer covering outside a piece of furniture or cabinetry. The majority of the demand for wood products comes from construction, where wood is used either as a structural product, as a layer, or for decoration. This is especially true for North America and Europe. Wood products have different degrees of ‘value added’ with respect to their original log qualities, from a simply dried and sawn structural lumber piece (usually classified as solid wood products) to a completely manufactured LVL or MDF piece (classified as composite or engineered products).

• Pulp and paper: The second big category of products made from wood is paper, including printing papers, tissues, cardboard, and packaging materials. The largest portion of the paper market is packaging, both containerboard used in transportation, and paperboard used for product storage and cutlery. A large percentage of packaging is made from recycled paper. Still, part of packaging, and other uses like tissue or printing paper require virgin pulp as well, which is made from pulplogs coming from the forests.

• Finally, we have a category called Other Cellulose, which groups several smaller industries made from pulp (also called cellulose). These include dissolving pulp, which is transformed into the viscose/rayon fabrics; and fluff pulp, which is used as the absorbent agent in diapers and similar products. Not included in the schematic are even more sub-industries derived from cellulose that make chemical products (acetates, carboxymethyl cellulose, microcrystalline cellulose). These are not covered in this article.

1. Forestry globally

Summary

• Wood can be classified into two types: softwoods and hardwoods. Contrary to their name, softwoods are used for applications where resistance is desirable, in both solid wood and paper products.

• A specific tree can be classified as a sawlog or pulplog. Sawlogs are larger, older, and of higher quality; they can be used for solid wood products. Pulplogs are younger, smaller in diameter, or may be damaged, and can be used for pulp or for composite products. The same tree can be partly converted into a sawlog and partly into a pulplog.

• Wood can come from both planted and natural forests (which is not the same as a virgin forest). Planted forests are more common in the Southern Hemisphere for hardwood and pulpwood, and natural forests are more common in the Northern Hemisphere for softwoods and sawlogs. Natural forests are plentiful, but harvesting them is usually a big challenge compared with plantation forests.

• A forest’s productivity is measured by two components. One is biological, the amount of wood it grows in a given year (measured in m3/hectare/year). The second, and just as important, is logistical, how easy it is to collect the wood, consolidate it, and transport it to the mills that need it.

• Wood in raw form is a very low-value-density product, and therefore, its trade between countries or regions is highly limited. This ends up determining the location of downstream industries that require access to ‘raw’ logs.

• Currently, many regions are suffering from supply limitations of forest wood, caused by political (Russian supply to Europe, Canadian regulation) or natural factors (calamities in Central Europe). These supply challenges evidence that wood is a generally highly price-inelastic raw material, where supply does not increase to adjust to demand in a context of higher prices.

• The current supply challenges of oil (this article is written at the end of March of 2026) will impact forestry above all.

The forestry industry sits at the basis of competitiveness across the forest products complex. Fiber costs make up a large share of the cost of final products, whether we are talking about pulp, paper, lumber, plywood, or panels. And unlike many other raw materials, forests cannot be relocated, nor is wood particularly easy to transport. Even within the same country, having a forest resource 50km away versus 250km away can be the difference between being globally competitive downstream or not.

In many geographies, supply challenges in forestry are driving a large share of the pressure being felt by downstream forest industries in the form of high delivered wood costs or outright low availability of timber.

This section reviews the basics of the forestry industry, the types of wood and forests harvested, the logistical challenges presented by wood, and how this ends up shaping the location of downstream industries.

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Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

After four years of very high nominal and inflation-adjusted interest rates, the Central Bank of Brazil (BACEN) is preparing to lower the reference rate SELIC. Market expectations are for rates to move from 15% today to around 12% by the end of this year, and 10% by the end of 2027.

This change can present opportunities among equities, many of which are really pressured by the current rate scenario. 15% nominal and 10%+ inflation-adjusted rates constitute a very hard environment for almost any business. There are not that many industries where a 15% return on capital is common, and given that high rates generate a drought of new equity capital, many companies struggle to cover their cost of capital.

This article provides an overview of 10 such businesses. They share similar characteristics: they are struggling to cover interest from operational profits; most of their debt costs are tied to variable-rate BRL debt; and some of them have operational/cyclical leverage to lower rates as well.

Some of them are potentially attractive on a fundamental basis, while others might be attractive vehicles for a speculative trade on bottom-line acceleration or lower-rates as a theme.

Mulher
Você vai gostar
Tô levando uns amigos (muito alavancados) pra conversar
Eles vão com uma fome (de lucro) que nem me contem
Eles vão com uma sede (de capital) de anteontem
Salta cerveja estupidamente gelada prum batalhão
E vamos botar água (liquidez) no feijão

Feijoada Completa - Chico Buarque - 1977 - Additions in italics by me

A more timely note: Olefins and the 2nd Gulf War

Writing about Brazilian leveraged names while the world debates the new Gulf War seems a little out of whack with current events, but it makes a lot of sense, at least in my opinion.

Macro and geopolitical events like this War are volatile and fleeting. It is the War today, two weeks ago was AI replacement and atoms vs bits, one month ago was dedollarization, and in one month it might be something completely different.

We need to abstract from explaining current events and analyze longer-term trends, to have a chance at having an emotional and intellectual framework that is not a prisoner of market sentiment and X feeds. So far, this has paid me good dividends. Some of the things I wrote about became ‘viral’ in the market later.

In this case, related to the war, I was lucky enough to analyze the olefin market late last year. Olefins are extremely affected by the current halt in trade between the Gulf countries and the rest of the world. Based on my analysis of this market, I believe US olefin giants like Exxon, Dow, and LyondellBasell are positioned to benefit substantially from protracted disruptions in Gulf maritime trade.

Following is a small note I wrote about the topic. You can also find much more detailed information in the three-part Primer I wrote about the olefins markets (Part I is currently free to read):

A great deal has been written about how a prolonged conflict in the Middle East could affect global oil and gas markets. Much less attention, however, has been paid to the implications for olefins and polyolefins.

That is surprising, because these are more concentrated industries, with fewer globally relevant players and clearer relative winners and losers. If disruption in the Arabian Peninsula proves persistent, the most obvious beneficiaries are likely to be the large American olefin producers, especially Exxon, LyondellBasell, and Dow.

The logic is fairly straightforward.

The US Gulf Coast producers already occupy one of the lowest-cost positions in the global olefin cost curve thanks to advantaged feedstocks. Their main rival in this respect is the Middle East, particularly Saudi Arabia, Qatar, and the UAE, which also benefits from abundant low-cost feedstock surpluses.

A regional conflict directly undermines the Middle East’s ability to compete. Refining and cracking infrastructure could become vulnerable to attack or operational disruption. Even if plants remain physically intact, exporting products could become more difficult and more expensive due to longer shipping routes, higher insurance costs, and heightened logistical risk. In addition, any decline in regional oil and gas production would reduce the availability of wet feedstocks, further eroding the cost advantage of Middle Eastern producers.

The effects would not be confined to the Gulf. In Europe and China, the other major consuming regions, feedstock costs would likely rise as well. That could happen through several channels: higher crude prices, more expensive and riskier transport, or reduced supply of Middle Eastern hydrocarbons and related feedstocks. In other words, competitors outside the US would face a more inflationary raw material environment at the same time that Middle Eastern producers themselves are impaired.

Finally, the US may experience the opposite dynamic domestically. Higher global oil prices would likely stimulate additional US upstream production, increasing the supply of associated gas and natural gas liquids. That, in turn, could improve the availability of wet feedstocks for Gulf Coast crackers and potentially lower their relative cost base even further.

This matters because the large American olefin producers generate roughly half of their sales and profits from export markets. Those export markets have, until now, been heavily pressured by two forces: low-cost Middle Eastern production and Chinese capacity expansion enabled, directly or indirectly, by relatively cheap feedstocks. A prolonged disruption in the Arabian Peninsula weakens the first force immediately and raises costs across the system more broadly, giving US producers a meaningful relative advantage.

Over the longer term, however, the picture becomes more complicated. One plausible consequence of sustained geopolitical instability is that China accelerates its push for energy self-sufficiency and strategic resilience. That could mean faster electrification of transport, lower domestic fuel consumption, and greater efforts to shift refining systems toward chemicals production. If so, the medium-term effect could be to increase chemical output and place renewed pressure on global olefin supply. I explore that dynamic in much greater detail in my second article on olefins.

Index of the main article

• The context of lower rates

• The method for finding opportunities leveraged to lower rates

• Company 1 - industrials

• Company 2- retail

• Company 3 - retail

• Company 4 - insurance

• Company 5, 6, 7, 8 - industrials

• Company 9 - commodities

• Company 10 - infrastructure

• Annex: Derivatives accounting and the upcoming IPCA swap revaluation

The context of lower rates

Brazil has maintained four years of very high inflation-adjusted rates. Brazilian inflation peaked at 12% YoY in April 2022 and has been below 6% since November 2022. Compared with this, the SELIC reference rate has hovered around 14% on average over this period, implying inflation-adjusted rates above 10% at times.

The Central Bank’s justification for such a monetary stance is that inflation has almost consistently remained above target (3%) and above the tolerance upper limit (4.5%). Further, after an initial period of rate cuts between 2H23 and 1H24, inflation reaccelerated, prompting the BACEN to return to a hawkish stance.

I have been fairly critical of the instrumentality of high rates in Brazil. Rates might be the only instruments at hand, given that fiscal policy is very rigid because of mandated expenses and indexes, but they are very imperfect. They generate a positive wealth effect among the richer strata of society (who earn 10% above inflation for having money in the bank); widen the consolidated deficit of the state; stifle investment that could improve productivity and resolve the inflation problem long-term; and may not even really reduce credit availability. I wrote more extensively about the fiscal and monetary problems in Brazil in the two articles linked below:

Independent of my opinions on high-rate policy, inflation is expected to decrease to 3/4%, that is, within the tolerated policy range, and the BACEN has already signalled its intent on reducing rates. The FOCUS expectations survey, a key policy-determination survey carried out by the BACEN, expects rates to decline to 12% this year and to 10% in 2027.

For a lot of businesses, 15% to 12.5% to 10% is the difference between life and death. There are not that many businesses that can earn a 15% return on capital, not even with 4/5% inflation. These businesses cannot earn their cost of capital at 15% rates. To this, we have to add the challenging consumer cycle in many domestic industries in the post-pandemic period. Finally, the complete drought in equity markets in Brazil (who would buy equity when the bank pays you 15% for holding cash equivalents?).

Further, most companies in Brazil issue variable-rate debt in BRL, meaning they are exposed to a decrease in rates. Of course, not all to the same degree.

It is in this context that sifting through ideas in Brazilian equity markets becomes attractive.

The method for finding opportunities leveraged to lower rates

The ideal company to benefit from lower rates is one that has the following characteristics:

• Currently fairly leveraged, and either not able or barely able to cover interest costs, using different metrics depending on the case (EBIT, EBITDA, EBITDA - CAPEX).

• Most of the interest expense is tied to BRL variable-rate debt. This does not mean that most debt is BRL, but rather that most of the cost is tied to BRL debt.

• Bonus: its operations present additional leverage to lower interest rates. Examples include downstream industry cycles (more construction) or consumer dynamics (higher availability or lower cost of installment credit).

If the company matches these characteristics, we can then analyze its income statement in more detail with a simple napkin model:

• Adjust operating income (or whatever operating profitability metric we are using) based on expected cyclical changes because of rates, if any.

• Adjust net financing expenses based on the current capital stack (BRL debt, leases, BRL securities).

• With these, we can find the expected change in pre- and post-tax income for the company.

Finally, a company might be an opportunity from a fundamental or a speculative basis:

• It is attractive on a fundamental basis if its market cap offers an interesting discount to our expected lower-rate earnings. For example, the company now makes R$200 million net; we expect it to make R$500 million with lower rates, and it trades for R$3 billion. What is attractive in this case depends on each person, but the source of returns is either earnings or a repricing triggered by what we believe is a fair multiple.

• It is attractive on a speculative basis if we expect the lower rates to trigger a repricing, even if its current market cap is overvalued in our understanding. This could happen because earnings improve, or because leveraged plays become a theme.

Each company in this overview meets the first two criteria above. In each segment, I introduce the company and its operational aspects (economics, cycle) succinctly, and then provide a ‘napkin model’ for lower rates (both 12% and 10% reference expectations).

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Derivatives make up a very relevant portion of almost any Brazilian company, much more than in other countries, even for industries that are not too exposed to direct foreign exchange risks.

The problem with derivatives is that their accounting treatment can take many forms, and that companies have a lot of leeway in determining how much to disclose and where. Further, the gap between accrual and cash accounting in derivatives can span years of operations. This can generate a situation where derivatives add a lot of confusion to both operations and financing, complicating the task of projecting the future.

This premier annex discusses how hedge accounting works under IFRS and under BRGAAP, both for rates and foreign liabilities, how companies might decide to account for these factors, and how we can try to dissect the true cost of financing for heavily hedged companies.

As a bonus, many companies have hedged IPCA (inflation) against the CDI (reference rate). These swaps have been terrible for the past two years, generating significant non-cash accrual losses on mark-to-market. I analyze how this might revert in the future, potentially boosting accrual net income for some companies.

Index

• The four main types of derivatives

• Derivative accounting options

  • Fair value of derivatives

  • Hedge vs non hedge accounting

  • Cash flow vs fair value hedge accounting

• The upcoming IPCA swap revaluation

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Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

Suzano is a synonym of Brazilian pulp.

The company literally founded the first paper factory in Brazil to replace imports during WWII, and carried out the R&D that enabled the production of paper from 100% eucalyptus pulp, without which today Brazil would not command the top global cost position in the paper pulp market.

After a series of mergers, the company today commands a large, cost-leadership position in the hardwood pulp market. Not only does it sit at the global bottom of the cost curve, but produces ~30% of global market hardwood pulp and 50% of the Brazilian market hardwood pulp.

This dominant position has allowed the company to command a reasonable pre-tax return on tangible capital employed, with good downside protection during cyclical downturns.

To the relatively good returns on capital, we have to add a key additional advantage: Suzano can issue investment-grade debt (BBB-, lowest tier) in foreign currency. Being an exporter, it can finance in USD at much cheaper rates than in BRL, without adding currency risk.

Good operating returns on capital and cheap(er) leverage allow for leverageable returns on equity.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

Opportunity and risks

The potential for opportunity stems from the fact that pulp and paper are markets under cyclical pressure from the usual suspects: Chinese overcapacity eating into domestic and foreign demand, the promise of additional capacity in the 2026-2029 range, and the risks of more muted demand growth going forward.

To this, we need to add intrinsic factors, like the ramp-up of production in a large CAPEX project (Cerrado project) coinciding with the cyclical downturn, and a strategic shift into downstream integration (JV with Kimberly-Clark).

The opportunity requires careful analysis, and this article provides that. It starts by explaining the industry, its cyclical drivers, current cyclical position, and forward demand/supply dynamics. Then, it analyzes Suzano’s asset structure, balance sheet, and capital allocation perspectives.

In total, this is a 6,000-word article that can provide a working thesis for understanding Suzano’s position, opportunities, and risks. In addition, a 6,000-word Annex double-clicks on specific cyclical and accounting factors, which I have not seen covered in detail in other reports on the company or the industry.

Index

• Pulp and paper industry basics

  • Downstream paper demand

  • Paper & pulp integration

  • Types of pulp fiber

  • Cost curves and forestry factors

  • Foreign trade dynamics

• Current cycle dynamics

  • China

  • Europe and North America

  • Latin America

  • Impacts on cost curves and clearing prices for wood

• Suzano’s pulp business

  • Pulp leadership

  • Sources of competitive position

  • Exposure to FX

  • Margins across the cycle

• Suzano’s downstream business

  • Capital allocation focus

  • Analyzing the Kimberly-Clark JV deal

• Valuation from a capital returns perspective

  • Profitability under cyclical downturn conditions

  • Uses of capital

Annex section: a deeper dive into specific factors in the cycle, modelling, and accounting

• Cyclical factors double-click

  • Chinese wood availability

  • Brazilian wood availability

  • Fiber to fiber and disintegration trends

  • Pulp price reporting

• Accounting & modelling

  • biological assets

  • hedge accounting

  • BRL accounting

  • adequate capital return metrics

  • net debt costs

  • taxes

  • Kimberly-Clark JV financials.

1 - Pulp and paper basics

The chart above shows a fairly complete schematic of the global paper market, from downstream uses on the left to upstream sources on the right. Paper is made from cellulose pulp, which itself is obtained from trees (virgin pulp) or recycled from old paper. There are two types of virgin pulp, softwood and hardwood, each obtained from different species of trees, and supporting different paper applications.

a - Downstream paper demand

Although paper seems like an outdated concept in our digitalized existence, it is still a growing market that underpins the modern economy, from everyday logistics to having clean buttocks.

The majority of paper demand and growth comes from packaging, including cardboard, which is considered a form of paper. Packaging is GDP-driven and is enjoying e-commerce and sustainability tailwinds. The majority of packaging is produced using recycled pulp, over which we don’t concern ourselves in this article that much, but it also generates growing demand for virgin pulp.

The larger virgin market is Printing & Writing, including stationery, books, and newsprint. Because of digitalization, this market is in secular decline almost everywhere in the world.

Next is tissue, including toilet paper, kitchen paper, and tissues proper. It is a mature industry in developed economies, but grows above GDP in emerging ones.

Finally, we have specialty, which is a catch-all going from high-end papers (like wallpapers) to food products like grease-resistant paper or paper cups and cutlery.

In aggregate, particularly in the developed world, this makes for a relatively mature market growing at ~ 1% to 2% per year. The sources of demand are mainly tissue and a percentage of packaging and cutlery that requires virgin fibers.

There are other specific markets not considered as part of the paper but that require cellulose pulps: dissolving pulps (used for viscose fabrics), and fluff pulps (used for diapers and other hygienic absorbents).

b - Paper & pulp integration

Within the paper market, we can distinguish between two types of paper producers: integrated and non-integrated.

Integrated producers produce their own pulp. Sometimes, they also own the forests from where the wood to produce the pulp is harvested. Integrated producers make up ~55% of the virgin market and the majority of the recycled market. Non-integrated producers purchase virgin pulp from the market and focus on paper production alone.

Because of logistics factors, integrated paper producers tend to be located in areas where forest resources are more plentiful. This includes Northern Europe, North America (both the US and Canada), China, Indonesia, and South America. In other countries, paper producers tend to purchase pulp from pulp exporting regions.

c - Types of fiber

Within pulps, we need to distinguish between softwood fibers (also called long-fiber, coniferous, or needle-leaf) and hardwood fibers (also called short-fiber, non-coniferous, or broad-leaf).

People refer to fibers by acronyms like BSKP (bleached softwood kraft pulp) vs BHKP (bleached hardwood…). To this, we can add even more details, like whether the pulp comes from the northern hemisphere (NBSK and NBHK) or the southern hemisphere (SBSK and SBHK), or even the species (like BEK for eucalyptus). What really matters is softwood vs hardwood; the rest is less important.

Softwood fibers come from coniferous species like pine, spruce, or fir. These fibers have higher strength, but are coarser and don’t absorb liquids well. The longer fibers also allow for better recyclability (given that with each round of recycling, the fibers get weaker). This makes softwood fibers a very important component of packaging demand. You want your boxes to be sturdy, to absorb little moisture/water, and to allow several recycling cycles.

Hardwood fibers come from deciduous (that is, falling leaves) varieties, of which the most important, by far, is eucalyptus. The short fibers allow for softer, brighter, and higher absorption products. Therefore, hardwoods are key for tissues, P&W, and coated specialties. Their disadvantage is a lack of strength.

Hardwoods are also historically cheaper than softwoods for several reasons. First, hardwoods are grown in more tropical regions, whereas softwoods require a more temperate or boreal climate. This makes hardwood more abundant than softwood. Second, hardwood requires less chemical treatment for processing. Finally, for historical reasons, softwood producers have older capacity (Europe, North America), with worse yields.

In real production today, fiber use is a mix of the natural properties of each fiber type, their relative price, and historical reasons. In North America and Europe, where softwood varieties are more common, mills originally produced almost entirely from softwood. Contrary to that, Suzano in Brazil developed 100% eucalyptus varieties of printing and tissue papers.

As a global pulp market emerged, and because eucalyptus hardwood is cost-competitive, mills have shifted to mixing softwood and hardwood in most uses. Today, hardwood makes up about 65/70% of the market-purchased pulp segment, but probably closer to 40/50% of the integrated pulp segment, with a significant skew to European and North American softwood integrated producers.

d - Cost curves and forestry factors

By far, independently of which cost curve is evaluated, Brazil is the cost leader in pulps, particularly in hardwood (eucalyptus), along with other southern cone markets (Chile and Uruguay).

The charts below show the market-segment cost curves for CIF China. As you can see, most of the hardwood curve is Brazilian and Chilean. South America is also a cost leader in softwood, but it has not developed that market as much because integration is higher in import markets.

The reason why Brazil is a cost leader is very simple: wood in Brazil grows very rapidly because of the appropriate climatic conditions. A forest in Brazil can grow at approximately 35m3/ha/yr, which is around 3x the average in China or Southern Europe, and 7/8x the average in Northern Europe and North America. Faster growth implies lower land requirements, lower labor costs, and lower risks.

Wood as a raw material makes up 50% of the cost of pulp. Indirectly, it makes up even more. For example, logistics can make up more than 20% of pulp CoGS, and logistics are highly affected by how distant the wood is from the mill. Lower productivity of land translates to a larger area needed to serve a mill, which translates to higher logistics costs. In addition, residue wood and components can fulfill most of the energy needs of an operation (80%+ in Suzano’s case, for example, inclusive of fuel and diesel consumption in the forestry operations). If your wood is cheap, your energy is cheap(er) as well.

This cost advantage opened a well of pulp production in South America, which became the globe's largest provider of market pulp to the expanding production in Asia (especially China) and to producers in Europe and North America trying to gain competitiveness by blending hardwood. Between 2008 and 2030, South American pulp production would have expanded from 15 million tons to 50 million tons, in the process flattening the hardwood cost curve significantly.

Note: In many reports (including Suzano’s), European or North American reported pulp prices are very different from those in China, up to 100% higher. This is not a real difference, but rather a reporting one (gross vs net). See the Annex for more details on this.

e - Foreign trade dynamics

Up until relatively recently, paper was not a particularly traded product category, particularly inter-continentally. Pulp, as we have seen, is primarily integrated into paper production (55% of paper production is pulp-integrated), albeit market pulp is obviously growing.

The global traded value of paper articles, excluding pulp and books, is ~$200 billion per year, and depending on estimates, the market size of paper is about $500/600 billion. If we net out intra-continental trade (Europe to Europe, Asia to Asia), the inter-regional trade is even lower as a percentage of the market.

Of course, there are net exporters, China and Northern Europe in particular, and net importers like the US, but even in those cases, it is mostly within the region. Based on my estimations, 75% of European exports occur within Europe. That same figure is 50% for Asia-Asia and 77% for NA-NA.

In pulp, the picture is a little different, with a larger share of market pulp (as we mentioned, about 40% of virgin pulp), most of which is traded inter-regionally (with LatAm as a big exporter and Asia as a big importer). Still, even in the case of pulp, integration (that is, same location consumption) represents ~55% of the market.

One of the reasons is again, logistics costs. We will see that Freight and SG&A in Suzano represent 1/3 of costs, similar to CAPEX or CoGS. LatAm can export inter-continentally because its CoGS is so much lower than the rest of the world that it remains competitive after adding transport.

The picture that emerges is one where paper is majoritarily produced within regions, and where pulp is also majoritarily locally produced, albeit with a significant portion of trade going from Latam to Asia (50% of Brazilian pulp exports, 80% of Chilean pulp exports), plus from Latam to Europe/North America (50% in the case of Brazil and Uruguay, 20% in the case of Chile).

2 - Current cycle dynamics

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Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

This Annex for the Suzano + Pulp and Paper Primer contains additional information valuable for readers who want to double-click on specific factors in the cycle and accounting. It is also the first published Annex exclusively for Premier Subscribers.

Quipus Capital has always strived to maintain a high-quality standard, with long, in-depth, well-rounded articles, while at the same time keeping them within manageable lengths. This will remain the same for all current subscribers of the blog.

However, I have also noticed that a subset of the readers may benefit from longer explanations on specific factors from the accounting or the market analysis. This kind of analysis is relevant only for some readers who want to research and carry out due diligence at a deeper level.

Because obtaining and compiling this data takes a long time, and because it is not relevant to all readers, I have decided to separate this kind of information into an additional tier.

In this way, I believe, everyone can still make use of the bulk of the information at a reasonable cost, while readers requiring a more exhaustive view can have that additional step as well.

Current paid subscribers to Quipus Capital can find a discount at the end of the Suzano article.

Specifically for this Annex, on the cycle side, I cover the topic of wood availability in China at length, delving into province-level inventories. I have not seen it reviewed in such detail in other reports on the pulp cycle. I also cover the topic of wood availability in Brazil, including climate change and other risks (like land substitution). Finally, an additional analysis on the prospects of fiber-to-fiber substitution and disintegration trends in Europe and North America.

On the accounting side, I cover factors that do not really modify the arguments around Suzano from the main article, but that are relevant for understanding Suzano’s financial statements. The company’s reporting includes several complex factors, like biological assets, hedges, and currency accounting, which can make reading the statements a little more challenging. Anyone expecting to do a deeper dive into Suzano’s financials will benefit from this section.

Index

• Cycle double-clicks

  • Chinese wood availability

  • Brazilian and Suzano’s wood availability

  • Fiber to Fiber and Disintegration trends

  • Pulp price reporting

• Accounting miscellanea

  • Biological assets

  • Hedge accounting

  • BRL accounting

  • Adequate capital return metrics

  • Net debt costs

  • Taxes

  • Kimberly-Clark JV financials.

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Continuing the analysis of the trucking industry and cycle from two weeks ago, this article provides an overview of the truckload carrier segment.

Truckload carriers are the most ‘pure-play’ of the industry’s segments, because of their exposure to for-hire rates, because they own large fleets of trucks and drivers (operational leverage), and because their lack of other meaningful competitive assets.

This makes them a leveraged play to the trucking cycle, and their stock prices have performed rather spectacularly in the past three months, in anticipation of a much awaited cycle turnaround.

The article provides an introduction to each of the companies, and applies a model for long-term cyclical valuation based on their returns on tangible capital employed, leverage capacity, and growth potential.

A long-term anchor based on what these companies can truly earn at peak, average, and bottom of the cycle, is important for more fundamental focused readers expecting to find companies for the long-term. It is also relevant, however, for speculative focused readers expecting to play the cycle, because it gives us an idea of whether expectations are depressed, fair, buoyant, or euphoric.

All of the overviews are open, except for the company that called my attention the most, which is behind the paywall at the end of the article.

On the road we go!

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

Truckload Carriers mini-review

Truckload carriers move full truckloads from point to point. They do so by operating (and owning) trucks and trailers via hired drivers, plus some adjacent assets like maintenance shops, truck stations (basically an empty plot of land where tractors and trailers can be dropped, plus a small admin and resting space), and not much more.

The complexity of a truckload network is not very high, and in some cases can be reduced to only owning (or even leasing) the trucks and hiring the drivers, with all adjacent services provided by third parties. It is low-entry and fairly commoditized.

Within truckload, we can differentiate three specific modes.

The simplest is one-way truckload for-hire, which is arguably the most commoditized and more exposed to spot rates. Most of the companies covered have tried to reduce their exposure to this segment, except for some cases (HTLD, KNX in part). The more a company is exposed to one-way, the more leveraged it is to the trucking cycle.

Another important mode, particularly for public companies, is dedicated, where the company manages fleets that operate for specific clients, usually doing scheduled routes. Dedicated is affected by the same commoditization and depends on the spot market, but contracts can be longer, and therefore, cycle volatility is a little lower. The stability can provide for better planning and asset utilization as well.

Finally, we have intermodal, which is a mix of shorter truck hauls (called drayage) and longer, usually intercontinental, railroad hauls. I don’t find intermodal has a lot more barriers to entry, because the key network assets are owned by the railroads, not the trucking carriers.

The EBIT/TCE method for valuing the carriers

The goal of this section and of the primer in general is to provide an estimate for the value of these carriers from a long-term perspective. For this, I use the pre-tax returns the companies have earned on their tangible capital employed in the past to estimate their earnings capacity today across a whole cycle (bull and bear).

Tangible capital employed is Total Assets - Goodwill and Intangibles - Working capital liabilities (excluding current debt and current leases). The numerator is EBIT/Operating Income.

From that pre-tax return on capital employed (including the bottom during bear markets), we evaluate whether it is safe to leverage and to what degree. Leverage is an important component of the valuation because it can increase the return on equity, as long as the cost of debt is lower than the average return on capital employed. I define the max leverage as the level of debt that would make interest expense become up to 50% of EBIT during the downcycle, based on an average rate of 7.5%. Of course, this is subjective, and others may be happy with higher/lower leverage. In general, the trucking carriers shun leverage, and my model generally finds ‘excess leverage capacity’. For the ‘levered’ scenario for growth, equity returns, and valuation, I substract the excess leverage capacity from the market cap (this is like assuming the companies take debt to pay dividends or repurchase stock).

After accounting for debt, we can find the net earnings to equity across the cycle and compare it with the current market cap of the company to find the earnings yield of the name. If the company did not plan to grow, it could pay this earnings yield to the equity in the form of dividends or repurchases.

Finally, we can account for growth. Growth, assuming a constant P/E across the cycle-average earnings, is equivalent to return (if earnings grow 5% and the P/E is fixed, then the stock price will climb 5%). Of course, growth has to be financed, and the part that is financed with equity subtracts from the earnings yield above. If the company has a low return on capital employed, it will not be able to leverage much, and therefore it will need to finance most growth with earnings, thereby negating all or most of the earnings yield, and putting a cap on how fast it can grow safely. The growth expectation of the model is the lower of the revenue CAGR in the 2015-2025 period, and the funding capacity to leverage.

The combination of the expected earnings + growth yield, plus some qualitative factors, gives us an idea of whether the name is undervalued or overvalued today. I provide a model for each of the companies, showing how each segment trickles into the valuation and return expectation.

Comparability of the period

The period I am using to estimate the cycle-average pre-tax return on tangible capital employed goes from 2015 to 2025. It is a complex period that includes a huge bull (21/22) and a huge depression (23/25), which is preceded by almost a decade of very mild cycles in the 2015-2020 period of high American growth after the GFC. Some might believe such an average underestimates the true average return, because it includes a depression that is too deep and too long. In my opinion, this is at least offset by the precedent high-profitability period of 2015-2020, and the bull of 21/22. In fact, I believe the average probably overestimates future profitability, if anything. However, the use of the current downturn as the threshold for leverage might reduce the leverage capacity of these companies too much, compared to a normal cycle.

Why EBIT and not EBITDA? Why keep ROU?

Some companies present their ROIC or other capital return figures based on EBITDA, and after removing lease assets (ROU) from the denominator. I believe this is misleading, at least for this analysis.

Starting with EBITDA, D&A in trucking is a real expense very close to a cash expense. The truck will most definitely not run forever, and even if used for an extended period, it will start to generate problems in other portions of the cost equation (higher maintenance, lower average speed impacting labor costs, higher fuel consumption). If we calculate the returns on capital before D&A, we are ignoring that at the end of its life, the asset will have no salvage value. It is like an Uber driver who thinks he’s making a lot of money without considering that eventually he will need to purchase another car.

Regarding leases (which admittedly are a larger issue for logistics and LTL companies than for truckload carriers), the problem is the capacity to finance capital. All assets in the balance sheet need to pay a return (except those financed by working capital liabilities, which are removed from the denominator). Therefore, all assets need to earn a return. This is especially true for lease assets, which need to earn their D&A (otherwise the lessor is implicitly gifting the asset), and also a financial return. If we remove leases, we are overestimating the aggregate asset return of the company, and therefore its capacity to leverage (leases are a form of leverage).

Speculation motives

This method leaves out the goal of speculating on the cycle itself, i.e., going long above an estimate of long-term value because we believe the market will further overpay. Still, an estimate of what the companies might earn over the long-term, compared to the prices of stocks, is a gauge of whether the cycle (as reflected in the prices of stocks) is depressed, already buoyant, or even euphoric.

I also do not use long-term P/Es or P/Es from specific points in the cycle. That would imply outsourcing the return requirement to the market. If the market has in the past valued a name at 18x P/E over cycle-adjusted earnings, but I believe it is worth at most a 10x, and it currently trades at 13x, then in my opinion, it is overvalued, not undervalued. Again, speculating on the stock reaching 18x or even higher during the bull is valid, but it is not what we are focusing on here. That speculation is much more dependent on sentiment and market psychology than on fundamentals.

General conclusions

The ‘promise’ of the public carriers is that by owning large fleets in the thousands or dozens of thousands of trucks, they are able to gain all sorts of efficiencies in asset utilization, overhead dilution, and level of service to the customer that the majority of the small carriers, which make up the bulk of the for-hire market, cannot reach. It is a ‘bottom of the cost curve’ strategy based on scale, borrowing from the language used in other commodities to refer to producers that earn a premium margin on the market because they are always the lowest cost producers in bull or bear markets.

From what I have seen, however, that does not seem particularly true, except for the larger companies in the market (first chart below). The majority of the smaller companies covered (second chart below) cannot exceed a 10% pre-tax return on tangible capital employed except during bull markets. Some are not even making money operationally anymore.

A low pre-tax return on capital complicates leveraging (it becomes risky during downturns, except at small levels) and therefore does not allow for high (post-tax) returns on equity.

In general, this would not be a problem to take positions in the industry if the assets were sufficiently discounted, especially considering we still are in the doldrums of a long downcycle. Unfortunately, I find that in most cases, the stocks are not discounted at all, but rather expensive already.

Assuming the companies are able to earn the average return from the past decade, the majority offer a return expectation (growth + distributable earnings yield) of less than 10%.

To me, the ‘opportunity’ presented by the stocks on a long-term fundamental basis looks like this: “If everything goes well, we go back to the post-GFC earnings environment, and we allocate capital efficiently, leveraging just enough to maximize equity returns while keeping risk at bay, and return all excess funds to you, your return is still less than 10%”. That does not sound attractive to me, especially for some companies that would rank quite low in the quality scale.

That does not mean this will remain like this forever. Many of these stocks have appreciated rapidly in the past three months, on the expectation of a cycle turn. If the turn did not become a reality, then the stocks might decrease to more attractive positions.

One speculative play

I have found that one stock (ULH) does offer a very interesting potential return (30% distributable earnings yield) if it is able to return to pre-downturn returns on capital. Interestingly, its returns have only recently collapsed, driven less by the overall cycle than by an acquisition and its specific specialty-industry cycle.

Of course, this ‘opportunity’ does not come without risk. The company is fairly levered, and at least in its last quarterly report, it was not able to cover interest from EBIT.

In my opinion, it is a speculative levered (operationally and financially) play into its specific trucking cycle recovery. You can find the analysis at the end of the article, behind the paywall.

J.B. Hunt Transport Services - JBHT

J.B. Hunt is probably the most qualitative play among truckload carriers, as shown in a fairly elevated average and even bottom return on tangible capital employed. Its lowest returns are better than the best returns of most other companies.

J.B. Hunt’s breadwinner segments are intermodal and dedicated (82% of assets, 85/95% of operating income). The company also participates in areas of logistics like last-mile delivery and asset-light brokerage, and has a small for-hire truckload operation, but these segments are less relevant.

In intermodal, the company is the market leader. I estimate the company has about 10/15% of the market ($6/7 billion in revenues versus ~$50 billion for the intermodal market). This might provide it with scale and long-term contracts that provide certain stability. Intermodal is a segment that tends to remain in demand in bear markets because companies try to cut costs at the expense of speed. During bulls, railroads tend to generate delays, and companies prefer to pay for full trucking freight. Still, pricing power and margins have declined significantly.

In dedicated the company also claims to be the largest, but on a much more fragmented market (I believe less than 5% of a $100 billion market). Still, the company has scale with ~13 thousand trucks servicing dedicated customers alone. The stability of this segment can be seen in a relatively flat EBIT/Assets of 18/17/17% in 2022/23/24, compared 25/17/12% for intermodal during the same period.

Overall, the position has a moat, which might be eroding slowly (as shown in a decreasing EBIT/TCE trend), but that is still higher during the bottom than most other carriers earn during their peaks.

The company’s founding family still has 18% in the company, and most members of management have been with the company for 2+ decades. Another quality point for JBHT is that it is the only company I have evaluated on trucking that discloses assets per segment, a key measure to understand segment-level returns on capital, and therefore judge capital allocation decisions.

Unfortunately, this ‘quality’ has a huge price. Both using a levered and unlevered model (the company could sustain a lot more debt than it does today, even assuming margins do not improve), very good average returns on equity (of 17% as currently levered and up to 45% if levered significantly but still conservatively considering past returns on capital), are offset by multiples of book value that cancel that potential return (4x and 11x respectively). The distributable earnings yield under my assumptions is LSD, and after adding some growth (CAGR of 7% since 2015), the situation barely makes a moderate return. I think JBHT has already priced the recovery, without considering the risks of a permanently lower average profitability level forward.

Knight-Swift Transportation - KNX

Knight-Swift is (or was) another quality name in truckload.

Interestingly, KNX managed to do that while being one of the few companies with (and maintaining) significant exposure to the for-hire truckload segment, which they call over-the-road (referring to longer distances than regional) truckload (45% of revenues in 2024, above 50% before the pandemic). This might be a good example of scale, with 22 thousand trucks in the truckload segment alone (about the same number as JBHT for all its operations). Originally, I believed a larger route distance might be a source of moat (regional players less able to compete in transcontinental), but this is not the case, with an average trip of ~400mi (LA to SF), which is about the same as most other carriers.

Besides for-hire truckload, the company also has dedicated (18% of revenues), logistics (9%), intermodal (6%), and less-than-truckload (18%) businesses.

The recent fall to very low levels of asset profitability is explained by the company’s mix (for-hire truckload is the most impacted segment during downturns and also the one that recovers the first and reaps the most benefits during upturns), but also by the acquisition, at the worst cyclical point possible (2021/22), of its LTL business.

The management of an LTL network is very different from TL (much higher fixed costs and network complexity), probably pressuring returns on capital. The company’s LTL segment has significantly lower margins than peers (12% at peak and 5% today versus 12% for SAIA and 25% for ODFL on a TTM basis).

This low level of current returns impacts the level of leverage allowed by my model, which, for safety reasons, would recommend the company to delever rather than lever up. If current low returns are a one-time thing and not representative of future cycle-bottom returns, then the company might leverage more and enhance returns on equity. Of course, this also embeds the optimistic assumption that returns will not be permanently lower.

Still, using average returns, the distributable earnings yield is LSD, which, added to the financeable growth (of 10%, hard to do without acquisitions, which have proved challenging in the past), reaches a higher low-teens level. In my opinion, this is not attractive given the embedded optimism of a return to the mean.

Still, KNX is probably one of the most levered plays to the cycle, because of its debt, and because it participates in the most rate-sensitive market.

Schneider National - SNDR

With Schneider National, we already have a significant fall in quality, as evidenced by lower average EBIT/TCE, and much lower during the bottom, removing potential leveraging capacity.

Schneider is an example of a company that has shunned for-hire truckload (Network in the charts below) in favor of dedicated. The company is already 50% smaller than J.B. Hunt in terms of revenues (its dedicated segment is 1/4 of JBHT’s, and intermodal is 1/6). The company also has a larger logistics segment (~20% of operating income), which should push returns on tangible capital upwards (low tangible capital requirements).

Schneider’s quality seems lower not only on the return on capital of the aggregate operation, but also on the volatility of the segments. Whereas in JBHT we saw the dedicated segment maintaining fairly stable margins, in SNDR the truckload segment (which admittedly includes a still relevant 1/3 of for-hire) fell from ~16% in 2022 to less than 4% today.

Again, even assuming pre-COVID returns, the expected returns for the company are MSD to HSD at best, and the premium to book is too high given the optimism. The stock price seems like a clear indicator of cyclical exhaustion.

Schneider is controlled by the founding family with a ~70% economic stake and 95% vote share.

Wern Enterprises - WERN

Werner Enterprises is another step down in the quality ladder (peak returns do not reach JBHT’s bottom returns).

The company shows that intrinsic factors are more relevant than the company's segments. It derives 50% of revenues from dedicated (theoretically more protected) and 25% from logistics (theoretically better return on tangible capital), with the remaining 25% from one-way truckload. However, its returns are not very impressive.

The cycle is obviously way below the previous average (even going back to the year 2000, EBIT/Total Assets ranged between 8% and 12%), but the company also made four acquisitions at peak cycle in 21/22, tripling its net debt.

It baffles me how a name like this can trade at 20x cycle-average earnings (which assume a return on tangible capital of 8% vs 2% today).

Marten Transport - MRTN

Marten Transport’s business is refrigerated loads. The company participates in for-hire (~50% of revenues), dedicated (~30%), and brokerage (~20%), but in all cases, refrigerated makes up 2/3 or more of the loads. The company owned an intermodal segment, but it was sold to Hub Group (HUBG). According to Jandel Research, the company is the 7th largest in the refrigerated freight industry nationally.

The average trip distance for MRTN is regional (~400 miles or the distance between LA and SF), potentially impacting the benefits of scale of a national player.

Obviously, the company is under a lot of pressure today, with truckload being unprofitable on an operational basis and dragging the rest of the business. Still, not even in this case do we get relatively attractive prices, with return expectations barely reaching MSD, with or without growth, and with or without leverage.

The company was managed and partially owned by the founding family. The son of the founder was CEO until 2021 and has recently returned to the position, and owns 22% of the shares. Another Marten surname shareholder owns 6.5%.

Heartland Express - HTLD

We are now entering the territory of challenged, very marginal names.

The company does mostly for-hire truckload, on a fairly regional basis (~500 mi average trip). The returns were not too bad before the pandemic, but then the company made several acquisitions in the peak cycle, reducing returns and increasing leverage (which is being repaid from underinvestment). It has been operationally unprofitable for two years.

The company is losing drivers (potentially related to underinvestment and selling trucks), which removes some of the upside during an upturn.

The average EBIT/TCE is influenced by fairly negative returns for two years already, but still, even if we assume the average ROTCE is 10%, we get an earnings yield without growth of ~6%, and an expected return with growth of about 7%. I truly cannot understand how a name so challenged trades at 17x+ optimistic earnings assumptions.

Covenant Logistics - CVLG

Covenant is more of a mix of segments.

The company derives 1/3 of revenues from Expedited (a modality in which two drivers share a truck to rest and drive continually), 1/3 comes from dedicated, and 1/3 comes from logistics (including a relatively higher-service subsegment called managed freight at 70% of logistics revenues).

In addition, the company owns part of a truck leasing JV that adds 1/3 of operating income, below the operating income line, as it is accounted via the equity method (in this case, I have the JV’s share of income to CVLG’s EBIT for the calculations above).

It is the only name performing better today than before the pandemic. This might be related to acquisitions (2018 and 2023 in Dedicated, 2022 in Expedited), and to the growth of the JV (from 1/10th of operating income to 1/3 today), which increases the EBIT/TCE because the only asset considered is the equity portion of the JV (it is a return on equity masking as EBIT/TCE).

CVLG’s CEO and his wife own 25% of the company, and have ~40% of the votes.

The returns expectations are not very good on an average basis, but this is admittedly less valid as an average for CVLG, given its business has improved instead of weakening. Still, even assuming an average return of 12% instead of 9.3% today, the return to shareholders climbs to low-teens only.

PAMT Corp - PAMT

PAMT Corporation is another operationally unprofitable carrier, and it’s the company with the lowest market cap covered in this article. The average EBIT/TCE returns of the company are among the lowest in the space, even before the pandemic.

The company’s business is almost entirely for-hire truckload (70% of revenues), with additional brokerage operations (30%), which are, nonetheless, lumped into the same segment. The company has a significant exposure to Mexican transportation (~50% of revenues), adding to the challenges of the cycle within the US.

Similar to HTLD, another for-hire focused carrier, the company’s margins collapsed because of its high exposure to the most commoditized sector. Revenues also decreased by more than 30% from the peak in 2022, in part driven by rates but also by disinvestment.

To this, we need to add leverage (the company would need at least 2/3% operating margins to cover interest, versus 8% negative margins today).

To cover interest and maintain cash, PAMT is actually net divesting in 9M25, reducing the potential for capturing a turnover in the cycle.

Considering its really challenged position, its low quality before current challenges, and the fact that its scale reduction will challenge full capture of the up-cycle, the company offers only a moderate HSD/LDD return expectation, assuming things improve a lot.

PAMT is the ‘sibling’ of Universal Logistics Holdings (ULH), owned by the same controlling family.

Universal Logistics Holdings - ULH

Disclaimer: I own shares of Universal Logistics Holdings (ULH).

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