Europe Equity Research 22 January 2021 Grow, Forest, Grow A toolkit for investors concerned about deforestation – Focus on Brazil and the Protein industry This reports explores the sustainability impacts and the financial risks related ESG & Sustainability research to deforestation and forest degradation, using Brazil as our key example. Based AC on the takeaways from JPM LatAm ESG “Protein” seminars, we discuss the key Jean-Xavier Hecker (33-1) 4015 4472 commitments taken by JBS, Marfrig, Minerva and BRF, and outline where we [email protected] see areas for improvement and opportunities related to regenerative agriculture. J.P. Morgan Securities plc Deforestation is an emerging theme for ESG investors. To date, investors Hugo Dubourg that include deforestation in their ESG approach are mostly driven by the (33-1) 4015 4471 [email protected] "sustainable materiality” of the theme’ (climate & biodiversity). As ESG AUMs J.P. Morgan Securities plc keep growing, we believe that a company which has significant exposure to FRCs and ignores related risks could suffer from a proportionate discount in LatAm Food & Beverages and Agribusiness valuation. We see this as stemming from several different ESG strategies: AC 1) Discount; 2) Outflows and 3) Missed opportunities. Over the long term, Lucas Ferreira these strategies are likely to impact valuations, resulting in a material discount (55-11) 4950-3629 [email protected] vs. a company’s historical average. Bloomberg JPMA FERREIRA <GO> Banco J.P. Morgan S.A. For countries such as Brazil, which holds 12% of the world’s total forests, deforestation represents a major issue, which has gained notoriety since 2019. Latin America and Brazil Equity Strategist Beyond its environmental impact, the issue has a geopolitical and economic AC dimension, as it can threaten trade deals and may result in economic sanctions Emy Shayo Cherman that would be detrimental to key sectors. Latest numbers indicate an increase in (55-11) 4950-6684 [email protected] deforestation in key biomes. We explore both positive and more controversial Bloomberg JPMA SHAYO <GO> legal developments around deforestation, as well as issues linked to oversight. Banco J.P. Morgan S.A. We stress that there is little hope to diminish the deforestation rate in the Amazon without finding an economically viable activity for the population that inhabits the area. Cattle ranching is a major driver of deforestation in Brazil. According to the Imazon institute, 88% of the amazon biome deforestation between 2010 and 2015 occurred in areas of potential cattle acquisition. In our view, increased efficiency in production would represent a significant lever to activate change, allowing for a decrease in deforestation, while tripling production. Meatpackers have been under strong pressure from shareholders and NGOs to take action. Yet, none of the producers have yet found a solution to fully trace indirect suppliers, albeit initiatives are ongoing, with JBS and Marfrig being most advanced on the issue. Broadening the perspective, we found that companies lack clear GHG reduction targets. However, we find the “carbon neutral” beef initiative interesting, and discuss the opportunity behind regenerative agriculture and how this may be applied in a Brazilian context. The final part of this report constitutes a toolkit for investors willing to examine deforestation further. This toolkit is divided into three main tools: 1) a JPM “Engagement questionnaire”, which highlights the key points investors need to pay attention to when reviewing companies’ commitments; 2) a mapping of sustainability certification for “forest risk commodities” (FRC); and 3) a list of databases which we think can be leveraged to roll out a deforestation screen for a larger universe of stocks. See page 59 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com Jean-Xavier Hecker Europe Equity Research (33-1) 4015 4472 22 January 2021 [email protected] Table of Contents Executive Summary ..........................................................................................................3 Why deforestation matters to ESG & mainstream investors .............................................................. 4 Brazil as a "case study” – highlighting the complexity of deforestation as a multifaceted ESG issue 6 Brazilian companies are starting to take action .................................................................................. 8 Is “carbon neutral” beef really possible?............................................................................................ 9 Broadening the discussion: our toolkit for Engagement..................................................................... 9 Losing 1,000 football fields every hour..........................................................................11 Forests represent 30% of global land area, with 66% of it in 10 countries....................................... 11 Deforestation and forest degradation are the biggest threats to forests worldwide........................... 12 Forest area is decreasing at an alarming rate, in spite of recent improvements at a global level ...... 13 Sustainable Materiality: deforestation as a key theme for SDG focused portfolios...18 A major role in climate change & biodiversity................................................................................. 18 A price to nature? Forests ecosystem services are not yet fully understood or quantified................ 20 Forests protection and restoration are sub-components of several SDGs ......................................... 22 Financial materiality: Investors are driving up the financial materiality of the issue.23 Regulators: in spite of an emerging regulatory landscape, the regulatory risks remain limited........ 23 Consumers: The reputational risk is increasing, but not driving consumer purchasing decisions in our view. .......................................................................................................................................... 25 Investors: the real driver behind the increasing financial materiality of deforestation ..................... 26 Corporates: starting to take action.................................................................................................... 29 Deforestation in Brazil: a case study .............................................................................30 Forest Magnitude ............................................................................................................................. 30 Understanding the Data: Deforestation and Fire Trends .................................................................. 32 Deforestation Drivers ....................................................................................................................... 36 The Regulatory Context ................................................................................................................... 38 A focus on Brazil’s Beef industry – The context...........................................................42 Cattle herd in the Amazon biome has been growing faster than Brazil’s total ................................. 42 Brazil’s average cattle raising productivity is poor .......................................................................... 43 Indirect suppliers: the main challenge of tracing origin ................................................................... 44 A focus on Brazil’s Beef industry – Companies taking action.....................................46 Meatpackers looking to improve animal traceability. Greenhouse gas emission cuts still in very early stages....................................................................................................................................... 46 JBS................................................................................................................................................... 46 Marfrig............................................................................................................................................. 47 Minerva............................................................................................................................................ 48 BRF.................................................................................................................................................. 49 Can regenerative agriculture practices result in a “carbon neutral beef”? ................50 Our toolkit to engage on Deforestation .........................................................................54 Our engagement questionnaire......................................................................................................... 54 1. Exposure.................................................................................................................................. 54 2. Management ............................................................................................................................ 54 Certifications and offset schemes – an overview.............................................................................