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The Brazilian Agrochemical Market under a Financial Perspective
Aug. 13, 2018
Overcome the peculiarities related to cultural differences, applied technologies, climate, soil characteristics, presence of pests, diseases and/or weeds, from the perspective of a Chinese manufacturer intending to participate actively in the Brazilian market, considered the largest in the world in terms of volume and revenue, the risks and opportunities of a business decision of this magnitude need to be carefully evaluated.
According to international consultancy Kleffman Group, the Brazilian agrochemicals market moved around USD 9 billion in 2017.
Source: Sindiveg, 2017 adjusted by LucrodoAgro
Source: Sindiveg, 2017 adjusted by LucrodoAgro
The difficulties imposed by the Brazilian legislation to register the agrochemicals are widely known internationally. In our view, it would justify a motion by China at the WTO against Brazil because there are a truly non-tariff barrier that seriously prejudice the free trade flow between the countries.
Despite the importance that the elimination of trade barriers means for the relationship between Brazil and China, we will deviate from this theme that has already been treated by renowned experts.
The focus of our work is on the necessity for Chinese companies to understand the Brazilian inherently market risks, especially with regard to the agriculture trade finance.
Differently from other countries where the financial system covers the most part of the necessity of working capital, in Brazil the agriculture credit lines are mainly supported by the input suppliers through their distributors network and by trading companies whom purchase export commodities (soy, corn, cotton, sugar, coffee, etc.).
The estimation is that the Brazilian banks cover less than 25% of the necessary financing.
In the recent years, many Chinese companies have been attracted to the Brazilian market with the information about the possibility to get expressive margins compared to other countries. However, this reality is not so easy and requires the organization of an expensive commercial platform considering the large extension of the territory, which additionally, it demands to grant a credit line for the distributors.
The commercialization of agrochemicals in Brazil is composed of an extensive network of 5,740 input resellers and 1,533 agricultural cooperatives, which responds for 49% and 24.3%, respectively, of the total volume. The corporative sales (direct consumers) corresponds to 26.7% of the global sales.
The term of the financing is usually denominated in accordance with the period when the farmers are finishing the harvest and receiving the first income of their sales. According to data from the SINDIVEG (entity that represents the agriculture inputs sector), in 2017 the sales of agrochemicals had the following composition:
The delinquency rate from the buyers was in the range of 9.60% in 2017.
The agricultural credit in Brazil is characterized by the financial scarcity and high interest rates compared to mature markets. The absence of a weather insurance framework aggravates the uncertainties to receivables liquidation.
In addition, the judicial system is much delayed and often issues contradictory sentences that generate more uncertainties.
How to avoid the main risks of default?
One of the best mechanisms used by the trading companies, mainly those that operate at the soybean market, its called Barter Trade.
This system was largely adopted also by the main agrochemical multinationals, such as Syngenta, Bayer, BASF, Arysta and so on in order to guarantee the receivables at the maturity.
The financial method has been improving the direct access to farmers and their production. Under the perspective of the big trading companies, the Barter Trade have been allowing to secure the raw materials origination and dampen the impact of price volatility without requiring the investment in expensive production assets and/or the acquisition of land.
The accounts receivable are usually collaterilised with the crop for which the price risk can be hedged on the Commodity Exchanges, such as CME and Dalian.
The securitization of the receivables can also be used to attract external funds from Banks and Investment Funds, lowering the risk exposure and the financial cost for the working capital.
Some Chinese big corporations like COFCO are ensuring the soybean supply, while taking the advantage of competitively of the agrochemicals costs produced in China in order to reduce their final cost or to improve the profitability.
The exchange of inputs by grains is normally made between suppliers, farmers and trading companies without the banking intermediation.
It’s estimated that more than 40% of the agrochemicals sales in Brazil and in the neighbor countries (Argentina, Paraguay and Uruguay) are made through the barter system.
The implementation requires a competitive product portfolio in order to capture a comprehensive part of the product cost at the target crop. Its also demands a solid relationship and knowledge of different aspects of the supply chain, such as the logistics and financial flows, legal conditions and the risk environment.
The players must have a deep understanding about the hedge mechanisms to mitigate the price fluctuation and to ensure the desired profit level. The environment complexity recommends to search a partnership with a solid international bank.
An example of a real operation (soybean deal)
1. The bank chose as partner receives the information from the client (reseller, cooperative and/or farmer) which the agrochemical industry would like to negotiate.
2. After to analyse the documents, the bank approves a credit limit for the target client.
3. The bank grants a credit facility to the client to purchase the inputs supplied by the agrochemical industry. In exchange, the client signs a “Futures Delivery Contract” of grains in favor of the agrochemical supplier by the equivalent amount of the purchase plus the interest rate.
4. The supplier signs a “Risk Participation Agreement - RPA” with the bank, keeping an equivalent deposit of the gross margin correspondent to the transaction. In the case of default, the bank shall pay “x%” of the contract value less the gross margin of the operation, which means that the capital shall fully protected ("Zero Risk”).
5. The client shall endorse or transfer the collaterals (“Futures Delivery Contract”) to the bank, which must be sufficient to cover 130% or more of the principal value plus the interest rate established for the period.
6. In the harvest period, the soybean or other exportable product shall be delivered as per previous instructions to the designated warehouses, which are monitored by a world class certifiers (SGS, Control Union, etc).
7. The export transaction must be closed with one of the international top trading (“off-takers), such as COFCO, ADM, Bunge, Cargill, etc.
8. If all the transaction runs well, the margin deposited as the “RPA” will be transferred to the agrochemical supplier.
9. The bank additionally will open an account on behalf of the agrochemical supplier to execute the hedge operations, that basically consist at the purchase of “PUT” options at the Chicago Mercantile Exchange.
Final Considerations
Due the scarcity of credit in Brazil, the inflation pressure and the negative consequences on the monetary policy which provokes a high volatility at the interest rates, the agrochemical suppliers must combine the commercial creativity with a solid risk management framework in order to gain market-share.
The Chinese companies have an extraordinary opportunity to increment aggressively their presence in Brazil and other countries from South America, taking the advantage of its solid economy and its robust demand for grains.
Click to download new business magazine – 2018 Latin America Focus (Bilingual edition: English & Spanish)
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