Fitch Rates U.S.J. - Acucar e Alcool S.A.'s Proposed Senior Unsecured Notes 'BB-'
Fitch Ratings has assigned Foreign and Local Currency Issuer Default Ratings (IDRs) of 'BB-', and an 'A(bra)' National Scale Rating to U.S.J. - Acucar e Alcool S.A. (USJ). The Rating Outlook for the corporate ratings is Stable. Fitch has also assigned a 'BB-' rating to USJ's proposed up to USD300 million senior unsecured notes due 2022. Net proceeds from this issuance will be used for general corporate purposes.
USJ's ratings are based on the company's reasonable consolidated financial profile with a moderate capital structure, its solid competitive position and business model within the volatile sugar and ethanol industry, and business expansion strategy. In September 2011, USJ created a 50/50 joint venture (JV) with Cargill Holding Participacoes S.A., called SJC Bioenergia Ltda (SJC), which includes an operational mill and large greenfield project that should increase USJ's standalone financial flexibility by bringing in a financially strong partner to help fund the company's expansion plan.
The ratings also incorporate the potential improvements in the company's debt profile following the debt issuance, which substantially lowers amortizing debt and reliance on funding with short-term credit lines, which should lower refinancing risks over the near term. Cash flow to service the proposed notes will mostly come from USJ's standalone cash flow and, in the future, the dividends to be received from SJC. SJC is not expected to produce meaningful dividend flows over the next five years.
USJ's ratings are limited by the company's exposure to the volatile sugar and ethanol industry and other risks inherent to the agribusiness sector. The ethanol industry dynamics are strongly linked to Brazil's regulated gasoline prices and related government energy policies. Contributions from the energy cogeneration activities, conducted through the joint venture, are small and do not mitigate cash flow volatility. USJ's ability to maintain the required crop investments is an important challenge. The maintenance of these investments is crucial for the group to support high industrial capacity utilization rates in order to sustain an increase in cash flow from operations (CFFO).
USJ?s leverage metrics are low for the rating category and have decreased dramatically over the last year as sugar and ethanol recover and due to the creation of the Cargill JV (SJC); USJ's contribution to the SJC joint venture consisted of an operational mill plus a greenfield project, as well as BRL1 billion of debt, and Cargill made a BRL350 million capital injection. For the LTM ended March 31, 2012, net leverage measured by net debt/EBITDA, was 2.4x for USJ on a standalone basis and 2.9x on a consolidated pro forma basis, which considers the proportional consolidation of SJC since the beginning of the 2011/2012 harvest period.
USJ's consolidated net leverage is expected to gradually decline to approximately 2.3x, from the current 2.9x by March 2014. Fitch assumed mid-cycle prices of sugar and ethanol and an increase in the production volumes due to the gradual start-up of SJC's second mill from the 2013/2014 harvest onwards in its base case scenario. In a stress case of lower sugar and ethanol prices, these ratios tend to weaken to between 3.0x and 3.5x. As of March 31, 2012, USJ's consolidated adjusted debt was BRL962 million, which compares positively to BRL1.2 billion reported in March 2011. For the same period, USJ reported net adjusted debt of BRL773.1 million, a 35% reduction.
During 2008 and 2011, average leverage measured by net debt/EBITDA was high at 11.1x, and was pressured by a sizeable capex and capacity expansion program, which were badly timed with the economic crisis and weak sugar and ethanol prices. The combination of better prices for the commodities and the JV with Cargill provided the reduction in USJ's leverage both on an individual and a consolidated basis.
Solid Business Profile, Cargill JV Positive
USJ has a broader product mix than its peers, so it can differentiate its product which allows it to capture higher margins. The company produces higher value-added crystal sugar versus raw sugar, which can command premium prices. The company also benefits from its location by selling its product under medium-term contracts to financially strong food and beverage companies within a 100km distance from the mill. USJ's contracts mitigate demand volatility although they are linked to volatile international sugar prices. Thus, USJ's joint venture with Cargill is a positive.
USJ should benefit by having a financially strong partner share in the funding of the expansion of the businesses through SJC. USJ's business strategy of focusing its mill located in the state of Sao Paulo (crushing capacity of 3.8 million tons of sugar cane) on higher value-added products is positive. USJ's current proportional crushing capacity under the JV is 2.5 million tons of sugar cane, which will increase to 3.75 million after the start-up of the greenfield project. The greenfield investment is adequately funded and include a long-term loan from the Brazilian National Development Bank (BNDES).
USJ also benefits from the complementary, large-scale production of its Goias mills, currently controlled by SJC, a long history with third party suppliers of sugar cane in the state of Sao Paulo, and lower leased land costs in its expansion area. The flexibility of its product mix towards sugar and ethanol also helps the company to manage profitability, vis-a-vis the price behavior of these commodities, which are established by the market. In the last harvest period, the sugar business represented approximately 59% of total revenues, versus an average of 63% in the last three harvest periods.
USJ's liquidity is satisfactory. As of March 31, 2012, cash and marketable securities amounted to BRL189 million. Liquidity ensured short-term debt coverage of 0.9x. This indicator compares with a ratio of cash/short-term debt of 0.02x in March 2011. Consolidated liquidity strengthened in 2012 due to the proportional consolidation of the JV's cash position.
On a standalone basis, the company has a strategy to improve its debt profile and financial cost, through the issuance of senior unsecured notes in an amount between USD200 million and USD300 million. USJ has debt maturities of BRL100 million between April 2013 and March 2014 and BRL147 million in the subsequent period, which are expected to be refinanced through, in part, the enhanced liquidity from the proposed notes. USJ's standalone net adjusted debt is BRL773.1 million, of which approximately 22% was due in the short term, and 30% being trade finance lines.
SJC benefits from a liquidity facility provided by Cargill Holding, which could be used in case of financial need given the risks inherent to the completion of the second industrial unit of SJC, in Goias. USJ has a substantial land portfolio (market value estimated at BRL1 billion), which also provides financial flexibility.
Negative Free Cash Flow due to Higher Capital Expenditures
Free cash flow (FCF) is negative but expected to turn positive by 2014. Cash flow generation was not sufficient to fully cover capital expenditures, which were higher than historical levels due to the need for larger crop investments to ensure higher industrial capacity utilization in the coming years and also due to the ongoing greenfield project in Goias. These factors led to negative FCF of BRL31 million in the LTM ended March 2012, funds from operations (FFO) of BRL179 million, and CFFO of BRL117 million on a consolidated basis, reflecting an increase in the company's working capital needs for that period.
Fitch expects FCF to become positive in 2014. USJ's FCF should benefit from the expected increased cash flow contribution following the estimates of a gradual increase in the utilization rate of the industrial capacity of the mill located in the state of Sao Paulo and the ramp up of SJC's second mill, from next year onwards, coupled with lower planned capital expenditures in the industrial plants.
Production Volumes Lower in 2011/2012
USJ's sugar cane crushing volume was 14% lower in the 2011/2012 harvest period compared to the previous year. The 11.4% reduction in the industry crushing volume in the Central South region of Brazil, as per UNICA (the Association of Sugar and Ethanol producers in the Central South), occurred due to unfavorable weather conditions and high average age of crops. Even so, USJ's consolidated net revenues slightly increased in March 2012 due mainly to higher sugar and ethanol average prices. In this period, average international sugar prices were around USD25 c/pound and the average prices for anhydrous ethanol and hydrous ethanol in the domestic market were BRL1.38/m3 and BRL1.19/m3, respectively. These prices when compared to the previous harvest period represented increases of approximately 12%, 25% and 24%. For the 2012/2013 harvest, Fitch considered the assumption that sugar prices should show a moderate reduction and ethanol prices should remain relatively stable.
In the LTM ended March 2012, USJ's net revenue and EBITDA without the effect of the fair value of biological assets (BRL56 million for the period) were BRL846 million and BRL386 million, respectively, on a consolidated basis. Although these amounts were higher than the BRL839 million and BRL199 million, respectively, reported for March 2011, the comparison is distorted by different accounting methods (implementation of International Financial Reporting Standards [IFRS] in the 2011/2012 harvest period, with relevant changes in EBITDA calculation) and by the constitution of the JV with Cargill in September 2011.
Key Rating Drivers
Negative rating actions could be triggered if USJ is unable to maintain its leverage in the current range and/or presents a relevant worsening in its cash flow from operations. Going forward, a faster than expected deleveraging trend of USJ on a consolidated basis coupled with improved liquidity position on a recurring basis could lead to a positive rating action.
Additional information is available at 'www.fitchratings.com`. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 08, 2012);
--'National Ratings Criteria' (Jan. 19, 2011).
Applicable Criteria and Related Research:
National Ratings Criteria
Corporate Rating Methodology
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