By Claus Born, CFA, Institutional Portfolio Manager, Franklin Templeton Emerging Markets Equity; and Preyesh Patel, Senior ESG Analyst, Franklin Templeton Emerging Markets Equity
In our new piece from the Franklin Templeton Institute, we examine the challenge of feeding a growing global population in the midst of climate change, geopolitical shocks and uncertainty. Claus Born and Preyesh Patel from Franklin Templeton Emerging Markets Equity believe systemic problems like climate change means sustainable practices by private farmers, ranchers and pastoralists in Brazil play an equally important role in delivering potentially carbon-free beef to consumers.
The following is an excerpt from the Institute’s recent paper, “Food innovation: Investing to feed our future.”
For over a decade, Brazil’s beef industry has faced pressures over deforestation as ranchers clear Amazon forests to make room for grazing livestock. Despite calls for corporate and regulatory changes from investors representing $US17 trillion in assets in 2019,1 and a subsequent intent to divest from Brazil assets in 2020 by 30 asset managers,2 Amazon deforestation accelerated in 2021. For our equity analysts, the threat of deforestation-related export bans from markets like China and Europe requires a thorough risk assessment for Brazil’s three largest meatpackers—JBS, Marfrig and Minerva3—responsible for 50% of Brazil’s beef exports in 2021.4
Our analysts in Brazil discuss three areas critical to gauging future market risks for Brazil’s meatpackers and sustainable beef production at the farm level:
- Digital tracking solutions. The ability to trace cuts of beef to a single animal and ranch already exists in countries like Uruguay. With a focus on food safety, many of the world’s largest beef exporting countries use national livestock tracking systems. This could be a silver bullet for Brazil’s meatpackers.
- Carbon-neutral beef. Sustainable beef production starts on the ground with farmers—long before cattle reach meatpacker auctions. Our analysts review new regenerative grazing techniques that farmers in Brazil, and across the globe, are using to boost soil quality and carbon sequestration.
- Carbon market incentives. There’s good news for Brazil coming out of COP26—namely, the ability to monetize the Amazon’s carbon sequestration capacity through global carbon markets. We discuss how carbon markets could accelerate sustainable grazing practices among farmers and ranchers.
Tracking cattle digitally
Today’s ESG spotlight on Brazil’s largest meatpackers isn’t new. Pressures to stop Amazon deforestation have been building for over 10 years. For our research analysts, direct engagement has been indispensable to gauging the sustainability of corporate business models and near-term strategies for navigating Brazil’s sprawling system of 2.5 million cattle ranchers and 446 meatpackers.5 Some key discussion points include ways to verify cuts of beef are free from deforestation and future impacts from export bans. For example, if a publicly listed meatpacker excludes all cattle linked to deforestation, this can reduce cattle availability and increase purchase prices, potentially impacting valuations. In this hypothetical scenario, we’ve modeled how smaller rivals (most Brazil meatpackers aren’t publicly listed) could increase their market share despite links to deforestation.
One panacea solution that often comes up in our discussions with meatpackers—tagging cattle with chips after birth to digitally track movements—has yet to arrive in Brazil. But it’s not a futuristic concept. Uruguay, Brazil’s neighbor to the south, rolled out a national cattle identification (ID) tag system back in 2004, placing readable chips on all livestock.6 Required by law and free-of-charge to Uruguay’s ranchers, these chips mean individual cuts of meat can be traced back to a single animal and the ranch it was born on.
Without similar traceability infrastructure in Brazil, and under sustained pressure from climate-conscious consumers and investors, JBS and Minerva are building out their own home-grown traceability systems. As Bloomberg’s interviews with Amazon ranchers reveal, it’s hard to see how the blockchain system under development by JBS can be foolproof without a legal system that enforces accuracy and compliance at the ranch level. What’s worse, Brazil’s legion of smaller meatpackers simply don’t have the resources to implement digital tracing systems. Given this backdrop, we see a growing consensus that Brazil’s federal government needs to step in and implement a traceability solution much like Uruguay’s.
Tackling carbon on the farm
For Felipe Villela, a Brazilian agribusiness expert and co-founder of reNature, a regenerative agriculture startup, livestock can be part of sustainable climate solutions when used properly. Indeed, some ecosystems don’t function properly without grazing animals.7 By integrating grass-eating ruminants like cattle or sheep alongside cropping systems, livestock can perform valuable ecological functions, like building up soil organic carbon through carbon sequestration.8
In Brazil, reNature not only helps farmers transition to scalable regenerative methods, it also links them to consumer packaged goods (CPG) companies eager to expand their zero-carbon supply chains. Take Brazil’s Marfrig, for example. In collaboration with the Brazilian Agricultural Research Corporation (Embrapa), Marfrig launched a carbon neutral line of beef in 2020 called Viva, produced by farmers who integrate livestock and cropping holistically.9 This effort dovetails with Brazil’s UN climate commitment to develop 5 million hectares of land that integrates livestock sustainably into cropping and forestry systems.
Brazil’s carbon market victory
At the close of last November’s UN climate summit, nearly 200 countries agreed to implement Article 6 of the 2015 Paris Agreement, setting out rules for a global carbon market. This opens the door to trading carbon credits with public and private entities and will ostensibly include offsets generated from agriculture, forestry and land use (to be ironed out after more UN meetings later this year). For Brazil’s environment ministry, this is a clear victory for the country.10 Brazil’s former minister of finance, Joaquim Levy, sees this as an opportunity to not only accelerate forest regeneration, but to expand Brazil’s low carbon agriculture programs.11
In the face of escalating climate risks, it is critical that equity analysts uncover future ESG risks and opportunities that can be easy to miss by just scrutinizing a balance sheet. In our discussions with Brazil’s meatpackers about deforestation bans, it became clear that national traceability infrastructure is a better solution than one-off systems that only a handful of meatpackers can afford to deploy. Without more support from Brazil’s government agencies, Amazon deforestation caused by cattle farming is unlikely to decline.12
Looking ahead, a global carbon market that confers monetary value to forests and farmland soils could be a victory not just for Brazil and the Amazon, but also for other rainforest countries like Indonesia and the global agriculture sector. That said, we think it’s unlikely that entities will buy carbon offsets from Brazil if large-scale Amazon deforestation from ranchers and farmers continues unabated. If big export markets like China move toward a European Union-style deforestation ban, we expect Brazil’s government will move quickly to enforce sustainable Amazon policies. More broadly, systemic problems like climate change means sustainable practices by private farmers, ranchers and pastoralists in Brazil play an equally important role in delivering potentially carbon-free beef to consumers.
What Are The Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors or general market conditions. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—prices of such securities can be volatile, particularly over the short term. Small- and mid-capitalization companies can be particularly sensitive to changing economic conditions, and their prospects for growth are less certain than those of larger, more established companies. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. Sovereign debt securities are subject to various risks in addition to those relating to debt securities and foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt. Investments in fast-growing industries like the technology and health care sectors (which have historically been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement. Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector. Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio. Franklin Templeton and our Specialist Investment Managers have certain environmental, sustainability and governance (ESG) goals or capabilities; however, not all strategies are managed to “ESG” oriented objectives.
1. Source: Ceres, Investor statement on deforestation and forest fires in the Amazon, October 2019.
2. Source: “Open letter from financial institutions to halt deforestation in Brazil,” June 2020.
3. Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
4. Source: Company annual reports, reference documents, sustainability reports, and investor presentations. Market shares are calculated based on production capacity, with the lower value assuming 150 working days per year, and the upper value using 250 days. There is no assurance that any forecast, estimate or projection will be realized.
5. Source: Brice, J. and T. Freitas. “Why It’s So Hard to Stop Amazon Deforestation, Starting With the Beef Industry” Bloomberg, December 17, 2020
6. Source: Davies, W. “Uruguay’s world first in cattle farming,” BBC News, November 26, 2004.
7. Source: Gabe, B. 2018. Dirt to Soil: One Family’s Journey into Regenerative Agriculture. White River Junction: Chelsea Green Publishing.
8. Source: FAO. 2017. Livestock solutions for climate change, Rome: FAO.
9. Source: Brazilian Agricultural Research Corporation (Embrapa), “Marfrig launches carbon neutral beef line with Embrapa,” News Release, August 8, 2020.
10. Source: Spring, J. and K. Abnett. “U.N. climate summit reach carbon markets deal,” Reuters, November 13, 2021.
11. Source: Levy, J. “Was COP26 A Good Deal for Brazil?,” Americas Quarterly, November 17, 2021.
12. Source: “Brazil’s Path to Sustainable Cattle Farming,” The Nature Conservancy, November 18, 2020.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.