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Tax disputes, price wars and pinhookers have all placed a damper on doing business in otherwise sunny Brazil.

Brandy Brinson

There are clouds on the horizon in sunny Brazil. Until now, it seemed that nothing could go wrong in this golden land. Resources were unlimited, labor was cheap and the political environment was favorable. Now, however, tobacco merchants are facing a tax dispute, farmer unrest and rising costs. The gold rush that occurred here is slowing.

To be sure, Brazil is still in the catbird seat. It has become the undisputed powerhouse of flavor flue-cured production in the world. Zimbabwe hasn’t recovered from its dive and probably won’t any time soon. The U.S. isn’t likely to regain its volumes either. Even with the quota buyout in the U.S., prices are still much higher than in Brazil—although that gap appears to be closing.

THE CROP. The size of Brazil’s crop this year is not as large as predicted. “We have reduced our estimate from initially 880,000 tons to approximately 847,000 tons green, which is basically the same volume as the 2004 crop,” says Claudio Henn, president of Sindifumo, the Brazilian tobacco trade association.

The flue-cured crop will be approximately 700,000 tons, about the same size as last year’s crop of 701,324 tons.

The quality is not as good as hoped for either. Initially, the dealers were optimistic, but a late drought from January through March dashed their hopes. The state of Rio Grande do Sul had already suffered a lack of rain back in November.

Buying began on Jan. 11 and will likely run through the end of July. “The receiving has been going slow,” says Henn. As of mid-April, only about 30 percent of the crop had been received.

“Normally we are supposed to have bought almost 50 percent by mid-April. The main reason was the lack of rain experienced since January up to mid-March. With the dry weather and very low humidity in the air, it was difficult for farmers to handle the tobacco without causing fragmentation and consequently more shrinkage. Today receiving is in full swing. We expect to finish buying by late July,” says Henn.

Henn says another problem dealers are facing is “pinhookers”—small buyers who come along and buy leaf from farmers who are already contracted with other companies. “They are unethical,” says Henn. The problem is not so bad this year because of the crop size. “There used to be more when the crop was small. But this year, there’s plenty of tobacco for everyone.”

“Last year, 10 percent of the crop was being handled by pinhookers, which is tough for everyone,” says Robert Jones, Universal’s president and ceo, South America.

“They’ve been a very negative influence on this market,” Jones adds.

PRICE WARS. The biggest problem facing leaf dealers, however, is price disputes.

This year, the U.S. dollar is around 13 percent weaker than it was during last year’s sales. Production costs are in Brazilian reals, but the crop is sold in dollars.

The exchange rate between the real and the U.S. dollar is currently us$1=BRL$2.60. “The rate has been very unfavorable for dealers. During last season (2004), the rate was close to brl$3.00 per dollar,” says Henn.

Not only is the exchange rate poorer, but costs also rose this year.

“What we are facing is the dollar issue and the appreciation of the real at 13 percent this year,” says Henn. “On top of this, fuel, energy and labor cost 10 percent more for the farmers this year.”

The industry agreed to pay farmers 10 percent more than 2004 prices due to increasing costs. The farmers had asked for 26 percent more, as there has been a 19-percent increase in costs according to their numbers, due to inflation of 7.2 percent and an increase of 7 percent for labor.

Dealers had hoped the manufacturers would help absorb some of the rising costs, but no such luck.

“The prices remained the same as per the meeting held with farmers representatives on Jan. 10 in Florianopolis—i.e. 10 percent over the 2004 prices,” says Henn. “The manufacturers did not agree to pay the additional 10 percent asked by the farmers’ representatives.”

One dealer says, “Brazilian tobacco exporters should get a 12-percent increase on last year’s prices to compensate the stronger real this season. This is not happening. Customers are not willing to pay this kind of increase. The hit is being absorbed by the dealers, who are lowering the already squeezed margins.”

He adds, “Top grades are bringing a reasonable increase. Medium to lower grades almost nothing. Competition to sell the big Brazilian crop is intense. Overall quality is only so-so due to the drought experienced at the final development stage of the tobacco crops.”

FARMER UNREST. Though the industry agreed to a 10-percent price increase for farmers, that was significantly less than the 19 percent they wanted. During price negotiations, there was quite a bit of turbulence.

Hainsi Gralow, president of Afubra, the tobacco growers’ association of Brazil, says, “Wherever there isn’t agreement on prices, there are problems.” Afubra expects problems with farmer dissatisfaction this season.

“Everything will depend on the grading criteria. If the companies get more strict, there will be problems. If they are more tolerant, there will be fewer problems,” says Gralow.

So far, there haven’t been any major disputes. “There have been no farmer strikes yet, and we do not foresee any strikes, although many farmers are not happy with their outcome in the present crop,” says Henn.

Gralow adds, “The farmers are not happy with the prices, but when they analyze the situation, they are still better off than switching to other crops.”

Plus, he adds, “There are thousands of dissatisfied growers, but there are thousands of other farmers just waiting for a chance to grow tobacco.”

TAXES. Meanwhile, tobacco exporters are facing another money battle with the government. The dispute involves a tax that is assessed on production by the federal government and is supposed to be reimbursed by the state once goods are exported.

Up until 1994, exporters paid an ICMS tax on exports. It was 8.45 percent and then dropped to 6.45 percent. At the end of 1994, the government abolished the ICMS tax for exporters as an incentive to boost exports.

The ICMS goods tax is now 12 percent but is supposed to be reimbursed once goods are transferred out of the state. “We are supposed to receive the 12 percent back when we export, but the state has not passed that on,” says Henn.

The two states that are not issuing reimbursements are Paraná and Santa Catarina, where nearly half of the tobacco is grown.

On Dec. 30, the government issued a decree freezing the reimbursement.

“The federal government hasn’t paid the states and the states can’t pay us,” says Jones. “In effect, they have reinstituted an export tax.”

Carlos Brand, finance admin-istrative director of Premium Tabacos, says “Right now there’s brl$150 million sitting in there. That could double to brl$300 million by the end of the year if things don’t change.”

Nestor Mähler, leaf director for Dimon, says, “At the end of the day, we are quite sure it will be a loss, because the central government is not paying back what they should.”

FUTURE PRICE INCREASE? Many exporters feel that if these increasing cost issues are not resolved, prices will eventually have to increase.

“The question is, can Brazil move these record crops at increased price levels?” Jones asks. “It will be difficult to move this crop and will probably lead to a decrease in crop size—maybe a 10-percent reduction.”

For now, the manufacturers aren’t paying up. “The dealers are going to have to take part of the cost; the farmers will probably also take a reduction in real prices. Eventually we’ll have to reach a new equilibrium in Brazil, probably by 2007,” says Jones.

The turmoil already has Universal putting the brakes on its investments in Brazil. “We’ve suspended all new investments here in Santa Cruz and Venancio Aires until this situation is resolved,” says Jones.

He adds, “We’re going to have to be very cautious here in Brazil. It takes time to work things out politically, but the market eventually corrects and the market sometimes forces change.”

BRAZIL’S ROLE. Now that Brazil is experiencing growing pains, there’s even more motivation for manufacturers to look to other markets.

“Most of the customers say it’s a risk for them to have a single source, because you can have a crop failure. So they’re looking into other sources,” says Philip Isleib, export account manager for Souza Cruz.

“The world would like to have another sure, politically stable source of flavor flue-cured and burley,” says Jones.

With the quota buyout in the U.S., prices have come down, but many believe not enough to compete directly with Brazil.

Jones says, “The gap that existed between Brazil and the rest of the world is closing. Brazil had the cheapest tobacco in the world and the U.S. was more than double the price. Brazil was probably too cheap, because of the undervalued currency. In 2003, Brazil was almost artificially low and the U.S. was artificially high. The U.S. has come down and Brazil is moving up. It was $4 for Brazil tobacco vs. $7 to $8 for U.S. Now it’s $4.50 to $5 for Brazil vs. $6.50 for U.S. So the gap is closing.”

Jones adds, “It’s the best chance the U.S. has had in a long time. Now it’s up to the American farmer to produce at a lower cost a high-quality tobacco.”

“The U.S. will reposition itself in the market,” says Isleib. However, Brazil should continue to outsell the U.S. “unless Brazil raises prices to the $5 level.”

Who else will compete with Brazil? “Africa is going to be a continued big gainer,” says Jones. Dealers say Zimbabwe will probably come back in volume but not in quality. It still has a long way to go to be professional again.

STABILIZING. The size of the Brazilian crop has probably reached its maximum. Willi Bernauer, director of Bernauer Engineering and Services, says, “Maybe the crop will increase here and there by 5 percent, but Brazil is stabilizing.”

“My personal opinion is that 800,000 tons is a good size for the crop based on sales volumes,” says Henn.

The explosive growth is slowing and dealers are now focusing on strengthening their operations. Mähler says, “There was a lot of pressure here to increase in a short time. We’ve done some big jumps, and now it’s time to consolidate.”

Leaps and bounds

This past year, leaf dealers continued to pour money into Brazil, installing state-of-the-art equipment to move the massive quantities through quickly and efficiently.

“The capacities of lines in Brazil are huge,” says Bernauer. “At 25 tons per hour, they are humongous. Everyone is putting in these huge lines. Universal is running one line that’s 30 tons per hour. The lines are improving with high capacity, and improving quality.”

ATC. This year, ATC will purchase 34,000-35,000 tons of flue-cured and 2,000 tons of burley. “We’ve made a fairly significant investment here and continue to make annual improvements to our facility to guarantee a quality product. Last year, we bought more land for future development. That is currently on hold until the market situation clarifies itself,” says Evan Campbell of ATC.

“Last year, we processed 30,000 tons and we are steadily increasing,” he says. “From 2003 to last year, we more than doubled our purchases and sales, and hope to reach a total volume of 60,000 tons by 2008.”

BRASFUMO. Brasfumo is purchasing 32 million kg this year, which is 25 percent more than last year. The company will purchase 27 million kg of flue-cured and 5 million kg of burley.

Oziel Klaus Kohn, leaf director for Brasfumo, says, “Brasfumo intends to grow 20 percent every year. We are hiring new technicians to cope with the projected increase of volume for crop year 2006.”

CTA. CTA installed its third threshing line in time for this year’s crop, complete with an innovative separator (see also “Floating,” and “Hands Free,” pages 50-56, Tobacco Reporter, March 2005).

DIMON. Three years ago, Dimon upgraded its factory in Venancio Aires, increasing capacity by 50 percent. Over the last two years, the company has done the same in Santa Cruz do Sul.

“We’ve doubled our capacity in four years,” says Mähler.

Dimon now has a processing capacity of 200,000 tons—120,000 in Venancio Aries and 80,000 in Santa Cruz do Sul.

“For this crop we are fixing a new line in Venancio Aires,” says Mähler. “It’s a brand-new line, designed in-house, designated for burley.” This brings Dimon to five lines in total, with one dedicated to burley.

This year, Dimon’s production plan is for a total of 170,000 tons—138,000 flue-cured and 32,000 burley.

As for the Dimon-Standard merger, Mähler says they will run as two companies until the end of the season—in July or August.

KBH&C. This year, KBH&C Tabacos is processing its biggest crop ever, expected to exceed 42,000 tons of Virginia and burley.

Along with Kannenberg e Cia Ltda., in Santa Cruz do Sul, the company has achieved certifications of ISO 9001:2000, ISO 14001, OSHAS 18001, and SA 8000:2001.

Through its Integrated Management System (IMS), KBH&C seeks continuous improvements through systematic evaluations. The company considers process indicators and goal achievements, as well as audits results and the degree of client satisfaction.

KBH&C now employs 131 permanent employees and 800 temporary workers.

PREMIUM. Premium continues to grow. The company’s first threshing line took only six months from the ground to up and running in April 2003. By the end of 2003, the company was already building 10,000 square meters for storage. New offices for sales, accounting and financing were finished in May 2004. Premium now has 110 permanent employees and 700 seasonal workers.

Last year, Premium received ISO 9001 and ISO 14001 certification, and the company is awaiting ISO 18001 certification.

Premium expects to process 22,000 tons of flue-cured and 2,000 tons of burley this year. For the 2006 crop, Premium is expanding its green and packed storage by 15,000 square meters. The company’s goal is to reach its processing capacity of 40,000 tons in the next five years.

SOUZA CRUZ. Souza Cruz recently reorganized its export structure. The team is concentrated in both non-BAT business and exports to BAT-affiliated companies around the world.

Souza Cruz grows five types of tobacco through the integrated system, totaling more than 210 million kg.

The galpão comum in fermented form is used for RYO in a “growing niche market that’s keeping steady,” says Isleib.

Souza Cruz is also expanding its production of light air-cured Maryland, which will reach 800 tons this year. The project was started 15 years ago. The leaf is also produced in the U.S. in the amount of 2 million pounds, though production has declined significantly in recent years. Thinner leaf styles are produced mainly for the Swiss cigarette market.

Isleib expects production to increase. “I think there’s a lot of interest because of the quality characteristics of this tobacco type, such as flavor, lower alkaloids and filling power.” He adds that the leaf is “very climatic-dependent during the curing phase. It’s a very hygroscopic tobacco and turns dark very easily.”

Souza Cruz has also installed a burley stem washer, using technology developed in-house. This process enhances the physical and chemical quality of the stems and offers the company a great opportunity to expand exports, says Isleib.

UNIVERSAL. The largest processing plant in the world is Universal’s Brazilian operation. The company is bringing affiliates in for training here. “As the center of the tobacco world, Brazil has a major strategic role for us as a corporation,” says Jones. “The integrated system here is a model that is being copied all over the world. We’re shipping people in from all over the world to go in and develop a model along this Brazilian system.”

He adds, “Brazil is taking on a more important role; this area will be critical for the tobacco world for [the] next 30 years.” He says that already there are more to-bacco experts and personnel in Brazil than anywhere in the world.

The factory is 10 percent larger than Universal’s Nash County, North Carolina, USA, plant. “We’ve been investing $25 million a year in Brazil,” says Jones.

However, with the new problems surfacing in Brazil, Universal is being more cautious. The company had purchased another new threshing line for Brazil, but with the latest turmoil, Universal is redirecting the line. Jones says, “The new line would have been for increased purchases in Brazil, but now the line is headed for Mozambique.”—B.B.