BRF SA
BOVESPA:BRFS3
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BRF SA
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Good morning, ladies and gentlemen. Welcome to BRF S.A. conference call to discuss the third quarter 2018 earnings. This call is being broadcast via Internet at our website www.brf-br.com/ir. [Operator Instructions]
Forward-looking statements about the company's business outlook, projections, results and growth potential are assumptions based on the management's expectations regarding the future of the company.
Assumptions are highly dependent on market change, on the country’s and the industry's economic conditions and on international markets, thus, are subject to change. As a reminder, this conference is being recorded.
This conference will be presented by Mr. Pedro Parente, Global CEO; Mr. Lorival Luz, Global VP; and Mr. Elcio Ito, CFO and IR Officer.
Now, we give the call to Mr. Pedro Parente so he can begin the conference. Over to you, Mr. Parente.
Thank you. Good morning, ladies and gentlemen. I would like to begin by apologizing for my voice. These are things that are outside our control, but let's move on with our presentation for the day.
The earnings achieved in the third quarter of 2018 are shown on Slide #3 now. They begin to reflect a recovery strategy at BRF, which we announced in June. We can clearly see operating results with an upward trend, better margin, active pricing of our products and an integrated strategy to plan our production and sales in addition to asset monetization.
In this scenario, we highlight again our commitment with a deleveraging goal in 2018 expected to close the year at 4.35x adjusted EBITDA at the company according to the operating and financial restructuring plan, which we'll be addressing later on today.
On Slide #3, we make a comparison our numbers for third quarter 2018 and second quarter 2018, and we also post the results of the third quarter 2017. As you can see, there is significant improvement in our adjusted EBITDA, improvement of 63%.
Third quarter compared to the second quarter, also a reduction, a significant reduction of almost 72% in nonrecurring adjustments. At the end of the day, our EBITDA reported is BRL 415 million in this current third quarter compared to a negative figure of BRL 301 million in the second quarter of 2018.
Naturally, it is not possible to calculate the percentage variation, but it is possible to say that there was a shift, a change in our turnaround of BRL 700 million in our EBITDA reported in the second quarter 2018 vis-à-vis the third quarter 2018.
In order to get to our net income from EBITDA, as you know very well, in this case, we have to deduct depreciation and include the net financial income, lower tax and nonrecurring items, just as we did this quarter in terms of the hyperinflation in Argentina. Now I kindly ask you to move to Slide #4.
On Slide #4, on this slide we show in a very summarized manner, but also in a powerful manner, a diagnosis of the economic financial status of the company today. We moved from adjusted EBITDA of BRL 604 million positive and we come to negative net income of BRL 802 million. So how does it happen?
Firstly, it happens owing to nonrecurring adjustment that I mentioned before, BRL 189 million, but also the depreciation of BRL 488 million coming from the net financial results, which is basically payment of charges, our debt, taxes, like I mentioned before, and hyperinflation in Argentina. We can clearly see that in order to turn negative net income into a positive number and this positive number representing the return on capital that we all expect to see, the company has to work in 4 pillars. And now I want to show you that we are very active in all these pillars, all these areas so that over time, and let us underscore this, these results take time for 2 reasons actually.
Firstly, because this company, the company's business, is a long chain business and it's only natural we all know it. And on top of that, in addition to time, we have to consider the prior status of the company vis-à-vis its performance in the market and also vis-à-vis its operations, therefore, requiring adjustment. We are going to talk about this again, adjustment in several areas.
So firstly, we need to improve the operating income. This is front #1. We are going to have several initiatives. We're already deploying these initiatives. For example, vis-à-vis, our commercial strategy.
On this slide, Slide #5, we are showing the measures that we are taking in order to improve the operation result. When it comes to revenues, we have our commercial strategy. We have a very good strategy, very well defined in the domestic market in Brazil, in the Halal market and also in Asia.
Clearly, we also need to be very active in our pricing, particularly in our major brands: Sadia, Perdigão and Kidelli. Now it's important to make it clear that this is not only restricted to the rising price but also combining our mix. As for prices, from August to September, we have 12% increase in our processed products. And In Natura products, over 20% increase from April to October, clearly showing a very active policy of our management.
Like I said before, it's also important to highlight our product mix. In Natura, lower value-added products versus higher value-added products like processed foods, processed products. We had an improvement in our mix of 3.7%, favoring processed products in the current quarter compared to the same quarter of the previous year. However, when compared to the second quarter of 2018, there was an improvement of 8.6% in processed products compared to fresh or In Natura products, therefore, an important improvement in our mix. And like I said, also improving our commercial revenue.
In addition, when it comes to our commercial efforts, we're also working very strongly to lower our losses stemming from FIFO and also from the stock out and disruption of failing to meet our customer demands. We're strongly working on this through our Brazilian market. And also in order to increase the number of customers and the number of SKUs or items by client and purchase from our company.
We are also working on channels. We have significant efforts to optimize the push/pull strategy. In other words, demand versus liquidation of products owing to changes in foreign markets, for instance.
We also want to work in many different channels like cash and carry, retail, routing, DDP. And we also want to have full recovery of the Food Service channel. As we all know, it is a channel that had many losses in our company. This is being considered right now, and it's a topic that is very significant for us.
And finally, innovation. Product innovation, more specifically. And not only innovation in the mix of presentation of new products, we also work on all topics related to packaging and also in the context of new weight in our packaging because we believe this is what our consumers really want.
So we clearly have a good commercial strategy. And once again, we highlight this is already happening and this is expressed in the figures that we posted and that I recently mentioned with the price rise and the change in mix.
As for costs and expenses, naturally, it is important to work in both areas. For expenses, we want to generate surplus, a surplus impact, positive EBITDA with several initiatives, and they are listed on this slide. And now I'd like to draw your attention to something that I always highlight.
This is just hard effort, business as usual, trying to search for operating excellence and excellence performance. This is how we manage to recover the company's income and not only promising there is no silver bullet. We just have to do the best we can, and we are very confident when it comes to all our initiatives related to better operating and commercial results. And this is very significant in these areas that are absolutely critical to our earnings.
As far front #2, which is related to nonrecurring adjustment, the main nonrecurring adjustment has to do with impact from the weak meat and operations Trapaça.
On Slide #6, we have an impact on the third quarter 2018, BRL 100 million vis-à-vis the third quarter of last year; and corporate restructuring, BRL 47 million this quarter, in the third quarter of 2017.
And it's important to mention that these measures that we announced now we are on Slide #7. This is related to safety, integrity and quality, which are nonnegotiable pillars of our strategy and certainly I'm fully convinced that for the future, the company will no longer have to spend more with these items because we already are in the state-of-the-art in terms of safety, integrity and quality. Like I said, this is nonnegotiable pillars behind our strategy.
Our next front has to do with depreciation. As we can see, the level of depreciation is slightly similar to the net financial results around BRL 500 million quarter-on-quarter, which is important impact to move away from our EBITDA and getting to net income. We started by deducting BRL 1 billion by quarter approximately, as you can see on the figures.
As for depreciation, and moving now to Slide #8, we have initiatives related to an increase in our asset turnover. We do need to improve our asset turnover. And this is very strongly tied to the second item on the slide, the second bullet, which is higher installed capacity, utilization.
This is part of the target and goals assigned by our vice president for operations. We want to have a better use of our installed capacity. And naturally, it involves the efforts of all our commercial VPs, Brazil, Halal, International. Another very important, which naturally has an impact on both depreciation and financial accounts, is divestment of operational assets. Cash generation in our project, like I said before, is to be around BRL 5 billion.
And now I'd like to draw your attention on front #4. We show some slides front #4 showing our initiatives. At first, they are not those that come from divestment of Argentina, Europe and Thailand, which we'll be addressing later on. But these activities, these initiatives we have BRL 500 million of noncore asset disposal reduction in our inventory, working capital and other initiatives. Therefore, 488 concluded and ongoing another BRL 700 million to BRL 800 million working capital. As a reminder, we have significant seasonality in the last quarter of the year vis-à-vis the use of working capital, the need to improve our inventory owing to celebrations and the holiday season. And naturally, there is a dramatic reduction in the last 2 months of the year.
We also have FIDC. We are in the quiet period. So all we can say that our goal is BRL 750 million. We have the bank and the implementation of all initiatives, but we cannot disclose further details right now. And like I said, other initiatives amounting to BRL 100 million.
So in these initiatives, we have approximately BRL 500 million and our estimate is additional BRL 1.5 billion -- BRL 1,750,000,000 until the end of the year.
Moving now to another very interesting item, which is the status of deleveraging.
Slide #10 shows something that we highlight again and again.
There is a question mark here, some anxiety. And we don't consider this to be so crucial. We have 2 phases broken down the slide. One phase shows nonbinding tenders. And as you can see, in terms of Argentina, we already had all the previous steps, teaser, NDAs, InfoMemos, offers. And 14 offers up to now, nonbinding offers. For Argentina and Europe, Thailand we already have met all the early steps, and we had 8 offers related to these assets. In Argentina, we had offers to all our assets over there.
Now we just started the second phase, the data room is open, both for assets Argentina and also in Europe and Thailand. The management presentation for Europe and Thailand is happening as we speak. So this is actually happening right now. We have the presentations ongoing in London. Due diligence is also ongoing. And out of the 14 offers, we selected 8 players to continue in the process, and we expect to have binding offers by mid-December. The same goes for Europe. Out of the 8 offers, we selected 5, 5 players. And like I said, due diligence is ongoing, and the binding offer is expected to happen in mid-December.
So Slide 11 is my last slide before I turn the floor to Lorival and other VPs. We have an overview of our program. We see that of the divestments of operating assets, we expect to raise around BRL 3 billion; for the other initiative, BRL 2 billion; totaling BRL 5 billion of those BRL 500 million have been already concluded. We know that there might have a concern because this is a program very much concentrated in the last month of the half of the year, but that's because of the nature of the operations and the divestment process. And we are working within a structured program with well-defined stages, and we are also working to encourage a competitiveness regarding our assets.
So we are calm regarding this program. Of course, not everything is on the hands of BRF, it also depends on the other players. But I know that this work is being done with a lot of determination. And once again, I want to draw your attention that we do not see here a flag, a yellow flag, that right now might be raised regarding the range and the reach of these targets. So -- and now, I will turn the floor to Lorival and rest my voice for the Q&A session. Thank you very much.
Good morning, everyone, thank you for participating on this call. I will start on Page 13 and the objective is to provide you a highlight on the main events of the businesses that we have now in this third quarter of '18 and to stress our priority for the next coming quarters in order to recover margin, and that's what we are working on.
In the first slide, we show a Brazil snapshot. As you know, Brazil works with processed food mainly, and that's where we have to tap into the benefits of the brand, and the strength of the brand and the quality of our products, which is one of the foundations, one of the pillars of our products. Along with that, the strength with this new offers we are very much focused in innovation. We already launched in this quarter a Qualy Light with zero lactose, but our objective is to increase margin and share by launching new products that will bring this not only practicality to consumers, but also health ability to our products. So this is a function that is important for us. We are focused on that and this is one of our priorities, which is to position our brands in this industry, in this segment with that characteristics and recovering share as well as market.
On the Slide 14, it's important to mention the exponential execution we are already working on from the second to the third quarter. You can see here a strong recovery of margin from the second to the third quarter, and that is thanks to execution. That's commercial execution we have positioned our products in the right way knowing how important it is to adjust prices in the In Natura segment as well as in the Processed segment, as Pedro has already mentioned at the beginning of this call. And also here, we should stress the customer service and the execution, especially with the number of products sold. And also, once again, the right execution avoiding the stock out. Here, we had a reduction in [ 5 0 ] expenses and 30%. And this is money, you know, this is a significant amount. We already had that inefficiency and that's what we're looking for. It's important to stress that this improvement does happen in despite of the adjustments of inventory levels that we are also working on. So as you know, we have high levels of inventory, and we are reducing those by managing inventories at an efficient way, the way we use those products. So even doing that, we still have that execution improvement and that margin improvement that you can see.
About the prior year, obviously, there is a margin drop, especially because of the increase in the grain prices. You know that this has happened. It was around 40% to 45%. This is something that happened. We are adjusting that into our prices, and this will keep on happening so that the company can go back to its right profitability and then transfer prices so that we can adjust this price increase in our direct cost without, obviously, leaving the focus on operating excellence, both in the direct and indirect costs.
Now turning to Page 15. About our position in the market Here our market share, we have lost market share, but it was a very low 0.6 percentage points. But that was because of price increase. When you increase the price, the market tends to follow it or not the coming weeks. So we have this adjustment regarding the market share, but our priority is really to have the profitability and to aim at better growth margins. We want to grow and also to have better margins.
And here, we maintained our active client base, and there is a good performance here and the price positioning, as you can see, both for processed foods as well as for margarine positioning and showing the strengths of our brands.
Above the Halal segment, I am now on Page 16. Here, we see a relevant position maintaining our market share and the importance of our position in that market. We do have a relevant footprint, and here, the share is up 750% and expanding even more in processed foods in a way that we can improve profitability, and this is one of the priorities as well.
On Page 17, we see the recovery of our margins with an increase not only of margin prices, the right position, but also an increase in volume. So here, the focus is always to increase processed, adding value.
And also regarding Turkey, we have the right mix of products. I was recently in Turkey and the operation is very much a focus. And we want to have -- to serve customers with health ability. We have the right margins there. A lot of margins that can be replicated here in Brazil. And there, we have a business of chilled foods, and we see an opportunity and a relevant footprint for the future as well.
And so we see a right position here and an improvement in processed and in margarine. Obviously when we turn to the international market and then we will be talking about that in the Slides 18 and 19, we have all the impact of the restrictions we suffered for European exports as well as Russian exports. Obviously, because of that, when these volumes are not there anymore, when you compare the impact of year-on-year, that's irrelevant. We lose almost all the EBITDA in the quarter, and that's why we are working on a better execution for Brazil for the Halal market. And also here, we had the restructuring announced in the prior quarter of our industrial units that produce and sell -- that sell -- the units that sell for those markets. We had to make these adjustments on those units, therefore, it starts to show.
And also, the [indiscernible] about Russia. As you have seen some plants are now unable to go back to exports to Russia. That does not benefit us directly. But we do have an indirect benefit because this volume of production will be sent to Russia also before it was sent to China. And therefore we will have here adjustment and the supply and demand. Our company was not listed to be able to export to Russia, but others were. So we will be able to have a price adjustments for pork meat here in Brazil. We should be benefited from that in the next few months.
About consumption, now I'm turning to Page 20, 21. Talking about the Southern Cone. We had a very efficient management in terms of cost in this region. There was an improvement in the EBITDA margin from the second to the third quarter and on the stabilization, vis-à-vis the prior years. And the main volume here and the main percentage of this operation as regarding Argentina, and we are already advanced in our divestment process.
So now I conclude the summary of the main highlights. I think that once again, our priority is commercial execution, recovery of margins in Brazil and the Halal market. Obviously, considering the impact that we had of extraordinary effects, so plants being shut down, both in Europe and Russia, measures that also have impacted the market. And now, I will then turn the floor to Elcio who will talk about the financial information.
Thank you, Lorival. Good morning, everyone. I will start with the working capital, and I would like to stress that the focus of the company and the management is strong cash discipline. Not only in the financial area, but throughout the whole company so that we can be following our goals and always with safety, integrity and quality.
On working capital, on Page 22, it's important to analyze the working capital with more precise and accurate. If you make an annual comparison, considering the seasonality of our business, the seasonality of the second crop and also the inventories for the celebration items that we have.
So comparing to past year, we had a reduction of 6.5 days. When we analyze the year-to-date, if we have that overview, that year-to-date overview, we had 10.7% of NOR vis-à-vis 9.7% of NOR this year. So a reduction of 1% of NOR, which is significant here, vis-à-vis, the working capital. When we compare against the second quarter of this year and then we have the seasonal impacts, we have the second crop, that's when we have an increase in our balance of inventory and values that's relevant. Because 70% of corn in Brazil is produced here during the second crop period of 3 months. So we take advantage of our inventory levels and our -- the position of our companies to have that additional inventory. We have the festive products that grow over the year, and we have the sales at the end of the year. We also have a discipline for finished products. We are adjusting here also little by little and in a very effective fashion our inventory levels. And for the frozen raw material, which has been one of the main challenges of the company since last year, we had a relevant reduction in terms of volume, BRL 104 million. But at the end of the day, we are talking about 40,000 tons of frozen raw material meats in general that are part of the process of streamlining and providing more efficiencies to the chain and so that we will be better off to face the cycle of 2019.
So this is what I had for working capital. Now turning to free cash flow. The highlight here is operating positive of BRL 106 million. And despite of all the working capital impact that I just mentioned, the CapEx is in line with what we had in the quarter of last year -- the same quarter of last year in a very disciplined fashion and with prioritization of our investments, always focusing on the capital efficiency. Pedro talked about that. This is one of the main objectives and the focus of our own planning, which is the better use of our assets and our CapEx [ or ] the management is totally based on that.
And then to conclude. On the Page of Indebtedness, Page 24, we have a leverage of 6.74x because of 2 important aspects here. First, FX. If we have had an FX at BRL 380 million, our leverage would be at 6.49x. And the main impact in here was the year-to-date EBITDA. We have here BRL 16 million vis-à-vis the figure that we had last year. So the combination of these 2 factors did bring up our leverage.
When we look at our debt profile, we had the renegotiations of the debt and maturities. We'll keep on having the discipline and the trajectory of improving efficiency, extending the debt already working and the refinancing for the coming years.
So I now conclude the call and the presentation, and we will open the session for Q&A.
[Operator Instructions] The first question comes from Luca Cipiccia from Goldman Sachs.
My question is about the Brazilian scenario. Looking at the fourth quarter, obviously in this quarter, we start seeing the price recovery and margin recovery. It was significant, but already had several headwinds. And I would like to ask you if you can give us some more color for about the fourth quarter, which is usually more favorable. Do you think the market will be responsive in terms of mix and competition? And what about the consumption scenario? Do you see an indication? Do you believe you will continue having the sequential improvement quarter-on-quarter on your mix and more importantly, on margin?
Thank you, Luca, for your question. This is Lorival. I will summarize what the fourth quarter -- what we have had for the fourth quarter and, obviously, we already have impact for that from the third quarter. What we mentioned in terms of price increase, both for processed food as well as for In Natura. And then when new talk about In Natura, both poultry and now also pork, we do not have in the third quarter a full understanding of this impact and so we start having a fourth quarter with an impact of -- and the posting of everything that has happened in the third quarter. So this is relevant to take into consideration in the fourth quarter. In addition to that, as you well said, the fourth quarter, that's when we have the holidays, and what we can tell is that we are doing very well in the festive products. We are growing when we compare that to the same period of last year. We still have October and then November ahead. This is very much -- but we'll see a concentration in December. But so far, the cycle that we are at, this show an improvement vis-à-vis the prior year. And that makes us very optimistic regarding prospective. And also, we are already doing a lot in terms of commercial execution with the sales team. Our position, as I had said, vis-à-vis several initiatives, and we expect that this will be happening in a consistent fashion over the next quarters. Not only in the fourth quarter, but also in the coming months. I don't have here a crystal ball that will turn the things from one day to another, but this is thanks to our work that we are developing consistently. Thank you very much.
Now just a quick follow-up. We can see that into this quarter current quarter, there were several one-offs and adjustments, lower EBITDA compared to the second quarter. So could you give us more color about directions for the future? Do you expect to see a reduction in impacts? Or what about the visibilities for Q4 in some of these variables?
Based on what we can see, this is the trend. You're right, a reduction of impact as events and circumstances in the past are over. So the impact will be lower. Maybe just some remnants, I mean, about the disclosure of operations, Carne Fraca and Trapaça. Maybe some one-offs, but there is a downward trend of these adjustments and impacts.
The next question is from Danniela Eiger, Bank of America Merrill Lynch.
My question is also about the fourth quarter and the outlook. Pedro made comments during his opening remarks that we should expect to see a release of seasonal inventories in Q4. I would like to understand if we should also expect cash generation in this quarter. Like Luca said, this is a favorable quarter to the company, so I'd like to understand if there is room for cash generation already in Q4. As for festive products, you said they are going up. I'd like to understand if this growth is by a volume or price? What about the performance of the mix? And do you expect to have an increase or additional price increase in Q4 on top of the third quarter?
Thank you, Daniela. Good morning. Let us answer your question. In terms of cash generation for Q4, the answer is yes, there is a positive expectation and then there are some relevant items. Firstly, in the third quarter, we build and set our inventory base for festive products, so we have an impact of about BRL 150 million. And over Q4, in October and November, we still build this inventory. And in December it was 0, this number. So speaking of the third to Q4, we have a gain of BRL 150 million. Another aspect is that over Q3, you also work on inventory of corn stemming from the second crop. This is when we buy, like Elcio said. And this is also said over Q3 and then over Q4. Even though you buy, you also use more inventory rather than buy it. So you have some relief, so to speak, and also a release of working capital that is turned into cash. Another important aspect is that we have a continuation of our efforts to reduce the use of frozen raw material. This was partially done in Q3. We already have, in October, this posted and we have this brand over Q4. So this is an absolute commitment to reduce that finished raw material inventory. So this is like a mantra to us because it does reduce and significantly release working capital. It lower our storage, cost and also third-party cost. And over time, there is a significant effort.
And we don't have to make adjustments as the maturity happen. So this is just -- we follow very thoroughly this with our executive committee. We follow each one of these initiatives, amounts, so we can also have this reduction. We already had a very significant reduction, almost 40%, and this also applies to the fourth quarter. So the answer is, yes, there will be a release of working capital, other initiatives, and that will improve our cash generation. In terms of festive products, in this case, when I refer to improvement, we have an improvement in volume. We do have improvement volume-wise. We do see improved volumes and also better price positioning. It's too early to say more about it because we still have November and December, the whole month of December, to have the final position of the final mix and the final average price to say and to give an appropriate answer to your question. But as we speak, I can say that when it comes to our volume indicators, they are going up. As for your third part of the question, like we said, there was a price adjustment, a price rise. We do expect to have further price increase in Q4. Our positioning is to seek for profitable growth. We want to be efficient in our operations just as if we see an impact brought by cost, grain, freight and others, naturally we will search for this profitability and adapt prices accordingly. So this has been done in the second quarter, third quarter since April, like Pedro said. So we do have this commitment with the company's profitability. So as we have an impact of our effect of macroeconomic, direct factors, the company will try to be more profitable and will make adjustments whenever possible.
So just to clarify, what you said about the impact in the cost of grain, are you referring to additional impact? If I understood it correctly, you could not offset past margins because the cost increase was stronger compared to what you passed the price. So is the idea to react to grain in the future? Or do you still want to work on margins?
Thank you for your question. Once again, if we have new adjustments and further price impact, we'll make adjustments accordingly, but we'll try to work on the mix whenever necessary. Naturally, grain is important, but it's not everything. And we do have our cost inflation as a whole, and then we have efficiency in other areas as well, reduction in other costs. And then we consider not only the price of grain but what we consider to be COGS in order to work on this equation.
Next question is from Leandro Fontanesi, Bradesco BBI.
I have 2 questions. The first is about grains. How do you see the cost scenario for the fourth quarter? There was a drop in the grain prices. But also, thinking about the company's strategy you had, you have said that you would increase inventory to tap in to better prices and to make more cash. So what is your strategy for grains in the future? And also, another question is about the price increase. What is the mindset of the competitors? How do you see that mindset? Do you believe all of them have the same understanding regards margin and improving profitability?
Thank you very much. This is Elcio. I will start by talking on your grains question. Yes, the scenario in the past weeks and the drop in the spot prices and remember, our chain is a long one, and we also have inventory. Therefore, we are in a process of realizing, and we are seeing the price increase. And this reduction will take a few months to show in our cycle and our cost of goods sold. And obviously, we do have a high level of inventory, and 70% of that reduction is realized in this 3 months. 30% of the season in the summer is lower because of climatic effect and all of exports. And this is the grain production, obviously, so we do have a strategy of having a higher level of inventory during this period of in between crops that historically, the prices in between crops are higher. We continue with our strategy of grains hedge. One thing is to have the real availability of the grains, and we are working for the second crop of next year to make sure that we will have the real availability of those grains. And the second part of this adjustment is the price exposure to grains, and we are following strictly our policy that has been approved with the board considering the historic prices. So we are really following our commitment of soybean. It always involves China and the United States. We are also following that up and closely, and that is affecting the premiums every week depending the discussions on those 2 countries. And this is a period of a very high harvest in the United States for soybean and corn. So planting and harvesting are favorable in the United States and in Brazil and also in Argentina. So at least, so far, we do have that scenario for the harvesting.
This is Pedro. About the price increase and how we look at our competitors. Obviously, what we can tell you is that the cost impact of that, we have suffered, and we suffered -- our competition also suffers. And we can say that about our past increases, we have seen a reaction, which was important for us to have just a slight reduction in the market share, but it was not very significant. So showing that the competition also suffers the pricing impact, they are also practicing prices increases when they need. So in light of the information that we received about their execution in the market, that's how we have this information.
Next question is from Lucas Ferreira, JPMorgan.
I have 2 questions. The first one is on Halal. Can you talk about that margin improvement in the region? And basically talking about Saudi Arabia, you have a better supply and demand balance after you adjusted that slaughtering issue. So I want to understand if in the fourth quarter, you see a volume improvement and how prices will be behaving after that adjustment. And also, I would like to understand if that margin improvement, especially the gross margin, you had an increase in prices that was significant, but does that also have to do with that inventory that was formed actually in the first half of the year? Does that have any effect in the gross margin? Because probably you were selling this prior inventory probably at a lower cost. So in the fourth quarter, can we still expect a margin that is close to the one that you reported on the third quarter? And my second question is on the international market. I realized that the gross margin in the international market has increased significantly quarter-on-quarter when compared to the second quarter, but we have not seen the same thing on the EBITDA. So I want to understand what happened. What's the impact to gross profit? Was there anything that happened that you can comment about? And do you believe that the EBITDA in the international market can improve?
Thank you, and I will start backwards. And after that, I'll turn to Patrício, and he will be able to talk about what are the expectations for the Halal market. Talking about the international market, we do see a relevant effect when you have less volume, lower EBITDA and lower margin, and these refer to expenses that you mentioned. And since we are in this divestment process, that involves process and expenses related to the process, whether for the process itself, for the structure and the units themselves that end up impacting it. And we did have some effect there, which explains partially the profit and these costs. Now about the margins that you mentioned for the fourth quarter and the third quarter, if that has also to do with the inventory sales, let's put this into a perspective. Remember that the inventory for finished raw material, this is not an inventory that is there for a long period of time. This is not an inventory that I got a year ago, that I had grains, that went to our centers at a very low cost, no. The fact that we are now selling these inventories now, that does not improve the margin in itself because these inventories were also being built over the year, in the first 6, 7 months of the year, so we already had the impact of the grain cost. And at the same time, when you have that effort, not only of the sale, but also the effort of reducing the inventory levels at a stronger pace, you have to make some commercial adjustment. So I wouldn't say that there are margin benefits with this reduction of the inventory levels, but rather, we do have an impact, of course, of this inventory level at a higher cost. And we try not to use them in products with larger margins. And so when we have those inventories going back to the right levels, and this is going to happen in the fourth quarter of this year, then we take off this pressure of our sales team of having to work with these inventories, and we will have a better execution. Combining that to the execution that we are holding of number of products sold and everything else, then, yes, we will be able to have an improvement after that execution. Just another comment. We had a margin increase, as you mentioned. And despite of this impact that Lorival, mentioned and this is an impact that at the moment of sale, we have to work with those margins. So when we no longer have a problem with the sale of inventory, as Lorival mentioned, we might then have a better margin and, then also, a final global EBITDA that will be better because we will have the effect of the sale of those products. And now I will turn the floor to Patrício. He can tell you a little bit more about the Halal market.
Thank you very much, Lorival. Well, you had 2 topics: the supply of Halal, if the volumes are already -- the volumes that are already going back to Saudi Arabia, and also about our prices. Well, Brazil as a whole was able to adjust to the demand that processed by Saudi Arabia. Some of the process was reactive, and we did lose some efficiency. But we had to work structurally. We have divestments in the process, and we then were able to have a better performance in quality and cost. So the commercial relations from Arabia -- between Arabia -- Saudi Arabia and Brazil, already back to 40,000 tons, and this should be maintained for the coming months. So the volume that Saudi Arabia needs is very close to historic levels. But what we don't have in Saudi Arabia today is industrialized and raw material for industrialized products. And then, with our platform in Turkey and Arab Emirates, we were able to address that very quickly. That's why we are at another level of results, and also, that's why we are gaining market share in processed foods. So to conclude this concept, our margins are growing very well. They are in line with historic levels, and we are doing well because we have a local platform that allowed us to -- we have industrialized products that cannot be processed in Saudi Arabia but in the region. And the process in Brazil is adjusted and with a better performance in terms of productivity.
The next question is from Victor Saragiotto, Crédit Suisse.
Just a quick question. We saw in the slides, you mentioned BRL 274 million working capital gain. But when we check cash flow, we can see use this quarter and year-to-date. Can you tell us more about it? Maybe I'm missing something.
Victor, Elcio speaking. Let me see if I understood your question. In reality, we did have some use of cash. On the one hand we managed to improve greatly our inventory of raw material, frozen raw material and finished product, net of festive products. On the other hand, we had some offset, natural seasonal moments, and they more than offset the reduction in inventory, like festive products and also the second crop. In reality, if we think about it all, we had cash use, but we also wanted to highlight that it was part of our early plan of monetization, having the specific levers of raw materials and finished product, which are under our management. And the bulk is reverted into Q4, owing to the festive products and a lower share of grain that we use over time. I would just like to underscore, Victor, coming back to your question, on the one hand, we follow this very closely. Highlighting what Pedro said in the very beginning, we have our guidance for leverage for 4.85x (sic) [ 4.35x ], which is a combination of cash, operating cash of the company and also the monetization of that we addressed before.
Perfect. Now on the slide, you showed a reduction in net debt over EBITDA. One of the initiatives concluded had to do with working capital, theoretically, BRL 274 million savings. This doesn't match with the numbers we see in the cash flow.
Lorival speaking now. Let me tell you something. What is in the balance sheet naturally is what happens. In the balance sheet, as you can see, we have all the lines of working capital, all the lines include an increase in inventory of second crop corn, increase in inventories stemming from festive products and also animal inventory. Everything is there. What we referred to as initiatives is the seasonal effect. Our initiative that we proposed to work with frozen raw material inventory and finished good inventory. On those lines more specifically, we already delivered the numbers we showed. Naturally, there is a seasonal effect. So this is not despite seasonality, and seasonality will capture the benefit of the initiatives that we're working on, plus seasonality in Q4. So in order not to be suspicious of what is being delivered, festive products, holiday season in December, December 25, and the inventory of that we're building right now that does have an impact and that uses cash over Q3 also happens in October and in November. And when we get to December, the whole volume is adequate. At the same time, when we build our grain inventory, stemming from the second crop, which also happens at this time of the year, now we have a higher use over Q4. So these are the drivers that will bring this balance. And at the end of the day, in Q4, there will be cash generation stemming from these initiatives. So I just want to highlight again, I understand your remarks, but it's also important to underscore our efforts, our initiatives and all the drivers that are being addressed so we can have this number, [ 434 ]. One of them is this working capital that was very detailed. And on top of those initiatives, we also have divestment. And I'm confident that when you do the math and you calculate all these numbers, you will get to the numbers that we posted.
Victor, Pedro Parente speaking now. You might have this kind of reading. Net of these initiatives, working capital use in Q3 would be higher than BRL 274 million, owing to the seasonal effects. So this is just one of the initiatives that make up the total working capital. So this is how we can make both information compatible.
Our next question is from Thiago Duarte, BTG Pactual.
I have 3 questions. Actually, the first question is the follow-up of the previous discussion about Slide 9 in your presentation. Just to understand it better, out of the effects that you consider to be completed and concluded, working capital already had an impact on Q3. That's how I got it. Now non-core asset sale, do you have the impact already? That's my question. Second question, I understand that you underscored a couple of times. You highlighted the outlook to end the year with a leverage of 4.35x. You never mentioned again the second, so to speak, guidance, that you gave in the past in terms of ending next year around 3x. Would you mind going back to that outlook? Just to better understand if there is any reason to think of a different number, higher or lower, just to try to bring the discussion to something more midterm. And my third question actually, also coming back to the previous discussion about the price adjustment, new price, a drop in market share, I would like to hear from you more specifically. In terms of consumption, when we discuss with companies, I think you already have a brand portfolio for Brazil that is quite solid: Sadia, Perdigão, Kidelli introduced this year, and also Qualy. So when we think about that market share that you posted, consolidated market share, 45.8% this quarter. Is there any number that you consider to be a natural market share to be pursued in your current brand portfolio? Maybe just trying to understand the price increase for the future.
Thiago, Pedro Parente speaking. As for non-core asset sale, these are completed operations, and they assume cash inflow which already happened in part and will also happen by year-end. We do have operations ongoing, deals ongoing, BRL 214 million. Part is already posted and the rest will be by year-end, ongoing, non-core. So cash inflow, the operation is concluded, so we are sure about this amount. As for the target for 2019, this is absolutely maintained. We're going to hit that target. And as for 4.35x, just to remind you, and not to have any noise by year-end, it considers the inflow of 2 investments, and maybe these funds could happen over the first quarter of next year, owing to FX. Things that come out of the operations, 5 billion, and only with this adjustment, which is nonrecurrent, owing to this difference. Though alternatively, 3x net debt over EBITDA next year, this is what obviously we want to achieve. And counting on all the operations, all our initiatives that we announced, disclosed and are deploying, although these initiatives are here, they are at their limit. They are delivering margin results. So it's important to take that into account. And once again, I'd like to say that considering the nature of the business and also all the problems that we are challenged with as a company, things do take time to happen. As for market share, we have a clear vision that market share for us is a natural consequence of a combination of 2 factors: volume, naturally; but also margin. We want to see an increase in volume, which is profitable. Therefore, naturally, we pay keen attention to our market share, but we also focus on profitable, higher volume, always delivering positive results. So we don't have a magic number or a target for market share, but we do have a clear definition that we have to run our business in a profitable manner. Volume, profit, this is our vision.
Very clear, Pedro. Still talking about market share. When we look at that relativity rate that you presented for Brazil for process of 115% in the third quarter, my question then is, do you consider this rate a fair one for your brand portfolio? Or do you believe you can expand that if you think about the brand equity of your products?
Thiago, this is strategic information, so I don't think we can disclose more information on it.
Next question is from Antonio Barreto, Itau BBA.
I would like to go back to Slide #9. It was very clear that this [ BRL 1.3 billion ] of working capital, these are additional initiatives, so consumption would be worse if it were not by that. My question is, in this BRL 1.1 billion, do you have any initiative that is interest-bearing, such as prepayment of receivables, something that is another instrument that's not FDIC? Also, you have the client account of worth BRL 376 million. So in this BRL 1.1 billion, do you have anything there that is prepayment of receivables that is not FDIC, the receivables investments fund?
Antonio, this Elcio. Yes, we do we have some prepayments of receivables, especially coming from the international market. This is not a new practice. We have been doing it, and depending on the volumes of the country, sometimes that's more or less taking advantage of the world interest rates. And also this is a way of optimizing our cash flow.
Can you disclose the amount and the interest rate, Elcio?
The amount that we have here, in addition to the prior quarter, is BRL 150 million.
In reals?
Yes, in reals.
And my second question is when we analyze the EBITDA adjustments, we see that within the operating -- the operations Trapaca and Carne Fraca, we have around BRL 150 million in terms of idleness adjustment. How much of this adjustment will no longer be recurring? Obviously, as it's been adjusted in the EBITDA, you have mentioned that this is nonrecurring. But when will it not happen again? I would say that you have 2 options: either the situation will improve in the international markets that are generating the idleness; or you will have an internal control process, reducing the structure of production. What drew our attention is that in this quarter, we saw a reduction in the number of breeders of almost 4%. You also had an integrated action of BRL 15 million. So it looks like you are bringing down a biological asset. So this BRL 150 million of idleness, do we have to wait for the improvement of the international markets? Or these initiatives on your production rationalization will adjust the whole process?
Well, just to put things into account, our idleness both for Weak Flesh and Trapaca, that is being restructured. When we talk about Operation Trapaca, we have to mention the layoffs and the collective vacation period. And these are the idleness that come from the process. So yes, this has impacted the working capital of the biological asset. And also in the financial area, because we are idle during this period, so as we recover volumes, and especially here for the chicken factories, this tend to reduce the idleness for the coming years. And there is another side of it, and whether integrated or idleness, but here we'll have a final impact which is the closing of some plants that we have and that we should not be resuming operations. And Antonio, adding to that, I think you have a right understanding when you talked about the reduction in the number of breeders because this is the adjustment that we have to make once we have the markets closed to us. So you know this is a long chain and the results and the impacts that will happen are happening. And you will see them in the coming months. We are monitoring that up and closely to exactly know up to when this is going to happen. And then, we expect that the for the next year, we already have an adjustment of the level considering that we understand that we have already done everything needed according to the current market conditions. Obviously, we are monitoring everything, the opening -- the market, the macroeconomic conditions of the market, the international market. That's why we are talking about this reduction. But this is the adjustment that we need to do because some markets were closed for us.
Okay. It's very clear, Lorival. So by your answer, I can say that even if those markets do not open, considering those adjustments, we might have a reduction in this idleness, right?
Yes, exactly.
Next question is from Alex Robarts, Citibank.
I would like start by Asia. The gross margin and the EBITDA, the negative drew my attention. And you have been talking about tariffs in China, the Hong Kong situation with swine. Also, the situation in Japan. Can you comment on how we should understand the margin if we are reaching the bottom? If in the short term, in the fourth quarter, you believe the margin will switch, will be positive? Or maybe the most important impact has been from Japan, but what would be an idea in the short term about the margin? And my second question really is about Europe. You said that BRF plants are not in the European's list. So since we are going into 2019, can we believe that next year, you might start exporting there? Or what would be a future step or an indication? What could you tell us here if it is really possible to go back into the European market?
Thank you, Alex. About Asia, and then it could be applied to Europe as well. It's really -- it was a really challenging third quarter. If we look at the fourth quarter, we might have an impact with the opening or reopening of the Russian market. Therefore, we could be benefited from that with the price recovery for the region, not directly Russia, but the volume that was directed, for instance, to China might go to Russia. And then, we could have a positive effect stemming from that. But this is not an effect that I should call [ for ] reversion of this scenario. The scenario is still a way challenging one with execution that has to be very precise and efficient. And then, we might have a positive impact because of this commercial issue. Now regarding Europe, and I am being very transparent and consistent to what we have been saying since there was the banning of our plants in the beginning of this year. We expect that this will come back. It will resume at the time we thought it would be, around 18 months. So we are not working with that possibility in the first half of the next year. So addressing your question, if we should start the year, going back to Europe, we, of course, would love it to happen, but that's not our base scenario, considering the work that is being done and all the procedures that have to be taken so that this happens. So we are working at a very conservative phase, but I should stress that all information that we are [ relaying ] to you, and none of these scenarios we're considering an anticipating -- anticipated return to Europe, neither a significant recovery of the Asian market. So this is a scenario that considers other Brazilian variables. Halal is still a challenging management in these 2 markets, both in the fourth quarter as well as the beginning of next year.
Okay. So to understand it well, in your budget for 2019, you don't consider this trend of an upturn or starting Europe again. Is that, right?
Yes, that's correct.
And finally, just to better understand. What about the release of these plants, Europe for instance? Is it tied to the investigation of the federal police? Or it's not related at all with this investigation?
Could you repeat the question? The investigation of the police, is that what you mean? If I understood your question well, this ban took place precisely in the same date of Operation Trapaca early this year. We don't see an immediate effect on any step of investigation of Operation Trapaca. Now what we have to be -- to do to have the plants back on the list is to show our initiatives in our plants, our controls, and then maybe we might expect to see a visit and inspection, technical, health parameters. But this is not tied to Operation Trapaca or anything of the sort, but rather to performance and quality and qualification of these plants. And that's why it's so time-consuming because these steps have to be met throughout the process.
This concludes the question-and-answer session. I would like to give the floor back to Mr. Pedro Parente.
Once again, I would like to thank you all for joining us today. Thank you for your questions. Like we said in the beginning of the call, we believe the earnings are beginning to reflect our recovery strategy. Operating results already posting improved margins, owing to several actions. Once again, we want to acknowledge and admit that this is only the beginning. We have this firm commitment of being very diligent in our performance. We have no doubt that we'll keep on delivering positive and increasing results, and we'll meet our goals presented in our strategic plan and reverse the downward margin already in 2019 and go back to historical margins in 2020. And starting 2021, we want to deliver very promising results and even above our historical margins. This is very diligent daily efforts, so don't expect from us any promise that we might fail to deliver. Particularly, don't expect magical measures. We don't expect to see overnight changes in quantities or qualities. We want to deliver increasing positive results, but also sustainable results. This is key to our management. Thank you very much, again. And let's move forward.
This concludes BRF S.A. conference call. Thank you all for joining us today.