- In order for market participants to better understand S&P Global Ratings' credit analysis of Brazilian sugar and ethanol (S&E) producers, we're providing a detailed study of the most important analytical factors.
- In our view, a key factor is efficiency level, measured by the spread between revenues and cash cost, weighted by each company's interest burden and scale of operations.
- We also use efficiency level to rank and compare Brazilian S&E processors that we rate, determining which of these companies can best withstand a scenario of low S&E prices.
- Aside from that, liquidity and capital structure also play an important role in analyzing credit quality of the sector's companies.
The S&E industry in Brazil is highly fragmented: the sector includes about 400 mills that have various sizes, regions of operations, and product portfolios. Below, S&P Global Ratings explains how it has analyzed rated S&E companies in Brazil. Our goal is to better reflect and rank the companies' credit quality by weighting their ability to generate free cash flows after accounting for all investments needed to sustain agricultural productivity, captured by their cash cost and revenue structure.
We currently rate nine S&E issuers in Brazil, and have analyzed more than 35 domestic industry players in the past years. This has given us a strong sense of how businesses compare and the main issues that cause players to deviate from their operational goals, apart from the highly volatile commodity prices and foreign exchange (FX) rate variation that affects Brazilian players overall.
In our view, operating efficiency, scale, and product diversity are the most important factors in determining the business risk profile of a company in this sector, while the ability to generate consistent free operating cash flows informs the financial risk profile. In our opinion, the best proxy for Brazilian S&E companies' efficiency is to measure the spread between revenues and cash cost, weighted by each company's scale. Then we subtract the companies' interest burden to estimate how much cash remains for expansion, dividends, or debt reduction.
S&E Industry Accounting
Reported EBITDA can vary widely among the industry's players. Since own sugarcane is a biological asset, it is booked as a non-cash cost on companies' profit and loss (P&L) sheets, according to International Financial Reporting Standards (IFRS). Companies then book crop treatment and planting renewal expenses as capital expenditures (capex), although they're recurrent. For third-party sugarcane purchases, accounting is simpler--entities treat them as cash operating costs paid to third-party cane growers. Thus, companies that produce a larger share of cane output from their own fields generate higher EBITDA margins.
Companies usually operate with a mix of their own and third-party sugarcane, depending on the specificities of the regions where they're located, and each type has pros and cons. However, there's also a plethora of production strategies that combine the two approaches: some companies perform the crop treatment investments for their suppliers, and others are responsible for the CCT (cut, carry, and transport) costs for some of the cane growers, especially the smaller ones. Both strategies deduct the expenses from prices paid for the cane delivered. Moreover, companies try to balance the average age of their fields and yields--the rule of thumb is that older plantations result in less productivity--which means companies might lower crop renewal rates to save capex at the expense of yields, and, ultimately, EBITDA.
We've seen that during times of financial distress, S&E companies--especially those with higher percentages of own cane--could reduce investments in plantations but keep their EBITDA unscathed in the short term, since the effects of tumbling agricultural productivity are mainly felt in the next couple of harvests. Even when investments are revamped, the average productivity of the damaged plantations might take a while to fully recover, given that sugarcane is a semi perennial crop that lasts roughly seven years.
As a result of all these factors, ratios that use the EBITDA calculation, such as EBITDA margins or EBITDA per ton of crushed cane, can be faulty in terms of accurately comparing companies' efficiency if analyzed in isolation.
Key Efficiency Drivers
Cost of production is particularly important for this sector. In our view, the most important component of a competitive cost structure is agricultural productivity, measured by tons of cane per hectare (TCH) and by total recoverable sugar (TRS; the amount of sucrose contained in one ton of cane). By multiplying these ratios, we arrive at the best proxy for agricultural yields: tons of TRS per hectare. Other factors also affect companies' cash costs, such as the average radius of the fields, freight expenses, industrial efficiency, and cogeneration capacity (where companies use the energy produced by burning the cane bagasse--biomass left over after sugarcane is crushed--for their own consumption and sell the excess energy to the grid).
On top of cost structure, we consider operating flexibility and commercial strategy--which can vary significantly among companies--as important competitive advantages. Scalable operations help to mitigate adverse weather conditions and impacts on a small asset base. Companies with superior operating flexibility can shift production easily between ethanol and sugar, and financial flexibility allows companies to hedge sugar production and carry over ethanol inventories to sell at optimal prices during the harvest season. These competitive strengths translate into stronger and more stable cash generation. We then weigh each company's production scale to analyze their ability to sustain high operating earnings per ton of VHP sugar (also referred to as unitary operating earnings) even amid larger scale of operations.
In our analysis, we measure sugarcane processors' efficiency by calculating the spread between revenues and cash cost per ton of VHP sugar equivalent compared among competitors, subtracting interest burden, and then balancing that by the scale of each entity. In our view, the efficiency level determines the companies that are most able to withstand a prolonged scenario of low S&E prices.
Our Cash Cost Study
We performed a cash cost study by factoring into our calculations mostly public information available in the companies' audited financial statements to make our analysis as transparent as possible. However, we made some adjustments when the information wasn't available in the financial statements, especially when calculating maintenance capex. To keep comparability, we also excluded other segments' revenues and costs from the companies' calculations, when relevant. We highlight that we used an average of fiscals 2018 and 2019 in our calculations. Additionally, efficiency rankings might change from harvest to harvest because climate conditions affect regions differently, companies invest (or reduce investments) in agricultural and industrial productivity, and companies are also prone to changes in the relative price between sugar and ethanol, depending on if they're historically more sugar- or ethanol-oriented.
We calculated the cash cost of each S&E company using the following rules:
COGS--Cost of goods sold. D&A--Depreciation & amortization.
On top of cash cost, we analyzed each company's revenue structure. There are significant differences in terms of unitary net revenues (meaning net revenues per ton of very high polarity [VHP] sugar equivalent) between players. These revenue differentials could result from:
- Storage capacity and credit access, allowing arbitrage with ethanol inventories;
- Sugar price hedging strategies;
- Flexibility to adjust the mix of S&E according to market prices; and
- The portfolio of products, such as the ability to produce white or organic sugar, or diversification through sales channels (branded sugar in the retail market, for instance).
In addition, we note that generally it's easier for smaller companies to generate more cash per ton of VHP sugar equivalent, since the smaller companies in the portfolio we analyzed are generally better located or control their cost structures better than companies operating several mills. The larger companies usually have some of their mills located in less productive regions, and don't benefit from specific advantages that some of the smaller companies (which are among the more productive) enjoy. Nonetheless, larger scale provides some protection against external shocks, and reduces the risk of significant volatility, especially from severe weather events.
Calculating The Best-Positioned Players By Efficiency
Chart 1 below illustrates the distribution of cash cost per ton of VHP sugar produced (also referred to as unitary cash cost) in quartiles, reflecting the total cash cost divided by the total sale of VHP sugar equivalent of the S&E companies we analyzed. Charts 1-4 use the data from the nine S&E companies that we currently rate.
By calculating the spread between the unitary revenues minus the cash cost, we arrive at what we view as the best proxy for the operating efficiency of S&E companies we rate in Brazil: unitary operating earnings.
When calculating the metric above in Chart 2, we didn't include cash interest expenses, since we aimed to calculate a proxy only for companies' operating efficiency. However, the more leveraged the company, the higher the share of its operating earnings it would have to spend to meet its interest burden. The chart below shows the unitary earnings after interest.
Finally, we consider the scale of the companies. We calculated the potential cash flow generation, weighting the unitary earnings after interest ratio by each player's total sales of VHP sugar equivalent. Chart 4 below shows the total cash generation available for debt reduction, expansion investments, acquisitions, and dividends.
Our Ranking Of The Best-Positioned Players
In our view, there's a strong correlation between a S&E company's potential cash generation and our ratings on it. Some differences may arise from other aspects not factored into our calculations, such as liquidity or group support.
Within our rated portfolio, the best positioned players to navigate Brazil's volatile S&E industry are Raizen Energia S.A. (Raizen; BBB-/Stable/--), São Martinho (São Martinho; BBB-/Stable/--), and Adecoagro S.A. (Adecoagro; BB/Negative/--). Their potential cash flows after interest expenses are within the first quartile in Chart 4. They also have reasonable scale, the ability to generate free cash flow, and good liquidity positions. Although Raizen's unitary operating earnings is worse compared to others in our analysis, it has a huge scale--with more than 70 million tons of crushing capacity--and is the only rated Brazilian company in the sector to have a strong liquidity assessment. São Martinho has one of the strongest operating efficiency in the sector, with significant scale and a long record of solid productivity metrics and low leverage, resulting in stable margins and strong metrics over a long period. Adecoagro, after a period of heavy investment in its cluster in Mato Grosso do Sul, should be able to sustain solid cash flow generation and competitive cash costs, although it will suffer the impacts of lower ethanol prices somewhat more than peers. The negative outlook on Adecoagro reflects the risk of potential metrics and liquidity deterioration because it is more focused on ethanol.
A second group includes Vale do Tijuco Açúcar e Álcool S.A. (Vale do Tijuco; brAA-/Negative/--), Jalles Machado S.A. (Jalles Machado; BB-/Negative/--), Cerradinho Bioenergia S.A. (Cerradinho; brAA-/Negative/brA-1+) and Cocal Comércio Indústria Canaã Açúcar e Alcool Ltda (Cocal; brAA+/Negative/--). These entities have healthy unitary earning after interest within the first and second quartiles, and have positive potential cash flow after interest expenses. Therefore, we believe they would be able to withstand sluggish commodity prices, but they lack the scale and more robust cash flow generation of the first group. Due to their smaller scale, they would be more susceptible to volatility risks stemming from commodity price shocks and adverse weather conditions. On top of that, we assess their liquidity profiles as less than adequate (either because they're currently under an expansion plan, don't have the ability to sustain a consistent liquidity cushion, or have strategically decided to hold up a larger portion of their inventories to benefit from better inter-harvest prices). However, some have somewhat stronger liquidity cushions than others, which are exposed to refinancing risks.
The third group--which has companies in the third and fourth quartiles in Chart 4--is composed of higher-risk companies that are mainly facing capital structure sustainability and liquidity risks, and posted negative potential cash flow after interest expenses. However, S/A Usina Coruripe Açúcar e Álcool (Coruripe; CCC/Negative/--) and Bioenergética Vale do Paracatu S/A (Bevap; brBB-/Negative/--), the two rated companies in this group, have been improving operating efficiency, which should result in higher unitary operating earnings. Coruripe has suffered from adverse climatic conditions, agricultural mismanagement, and a lack of production flexibility to benefit from more profitable ethanol prices in the past few harvests, but should benefit this harvest season from a timely sugar hedging strategy and heavy investments in productivity, while Bevap is ramping up its plant, and has also converted a significant part of its debt into equity, reducing its interest burden.
|Company name||Ratings||Business risk profile||Financial risk profile||Liquidity assessment||Approximate crushing capacity (mil. tons of cane per harvest)||Comments|
|Raízen||BBB-/Stable/--||Satisfactory||Intermediate||Strong||Over 70||Largest company in the industry, operating 26 crushing mills. We consider just the figures for Raízen Energia S.A. for comparability with sugarcane processors.|
|São Martinho||BBB-/Stable/--||Satisfactory||Intermediate||Adequate||23.5-24.0||Operates three mills in the state of São Paulo and one in Goiás, including the largest mill in the world--São Martinho mill.|
|Adecoagro||BB/Negative/--||Fair||Significant||Adequate||13.0-13.5||Operates two mills in the states of Mato Grosso do Sul and a smaller one in Minas Gerais. It also has sizeable grain and dairy operations in Argentina, which we don’t factor in the cash cost calculations.|
|Jalles Machado||BB-/Negative/--||Fair||Significant||Less than adequate||5.0-5.5||Operates two mills in state of Goiás and produces organic sugar.|
|Cocal||brAA+/Negative/--||Fair||Significant||Less than adequate||8.5-9.0||Operates two mills in the state of São Paulo and is a Copersucar member, which warrants liquidity and logistics advantages, but lacks commercial flexibility.|
|Cerradinho||brAA-/Negative/brA-1+||Weak||Aggressive||Less than adequate||6.0-6.5, plus slightly over 560 thousand tons of corn||Operates one sugarcane and an attached corn ethanol plant in the state of Goiás. Lacks diversity toward sugar, but produces ethanol, energy, DDG (distillers dried grain), and other by-products.|
|Vale do Tijuco||brAA-/Negative/--||Weak||Aggressive||Less than adequate||7.0-7.5||Its parent company, Cia Mineira de Açúcar e Álcool Participações (CMAA), operates two mills in the state of Minas Gerais.|
|Bevap||brBB-/Negative/--||N/A||N/A||Weak||4.0-4.5||Operates one mill in the state of Minas Gerais, and 100% of its plantations are irrigated.|
|Coruripe||CCC/Negative/--||N/A||N/A||Weak||15.0-15.5||Operates four mills in the state of Minas Gerais and one in Alagoas.|
Efficiency Helps Better Compare Different Companies
In the highly fragmented Brazilian S&E sector, we believe that measuring efficiency enables us to better compare different S&E companies. We measure sugarcane processors' efficiency by calculating the spread between revenues and cash cost per ton of VHP sugar equivalent, subtracting interest burden, and then balancing that by the entity's scale. In our view, there's a notable correlation between S&E companies' efficiency and our ratings on them, which capture our business and financial risk profiles assigned to the companies. The main deviations are due to liquidity or capital structure, which aren't included in our analysis.
This report does not constitute a rating action.
|Primary Credit Analysts:||Bruno Matelli, Sao Paulo (55) 11-3039-9762;|
|Flavia M Bedran, Sao Paulo + 55 11 3039 9758;|
|Victor H Nomiyama, CFA, Sao Paulo (55) 11-3039-9764;|
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