Fitch Rates Tereos's Proposed Tap Issue 'BB(EXP)'
The final rating is contingent upon the receipt of final documents conforming to information already received.
Fitch does not expect the proposed issuance to have significant impact on Tereos' credit profile as the company will use most of the proceeds to refinance more expensive bank facilities. If not all of the proceeds are used for refinancing, a potential - although likely limited - increase in gross leverage could be offset by greater financial flexibility due to a lowered interest burden. Furthermore, this will help further diversify the group's sources of funding and extend average debt maturity.
The IDR of Tereos continues to reflect its weak credit metrics, which likely bottomed out in the financial year ended 31 March 2016 (FY16), as well as a strong business profile. The company maintains a strong market position, supported by well-invested assets, access to some of the higher-yielding sugarbeet regions in Europe and growing diversification in terms of geography and raw materials. The cooperative ownership profile of Tereos also contributes to its conservative financial policies.
KEY RATING DRIVERS FOR THE NOTES:
According to the bond documentation, the minimum of EUR500m (existing EUR400m plus tap issue of minimum EUR100m) senior unsecured notes due 2023 and the EUR500m senior unsecured notes due 2020, both issued by Tereos Finance Groupe 1, rank pari passu in the group's debt structure. They are guaranteed on an unsecured basis by Tereos, and are therefore subject to structural subordination not only to debt at Tereos Sugar France (TSF) but also at Tereos's 78%-owned subsidiary Tereos Internacional (TI). TI's debt is non-recourse to TSF's assets; therefore we exclude it from the amount of debt ranking above the senior unsecured notes in the payment waterfall in case of default.
However, due to cross-default provisions linking the debt of TI's subsidiaries, TI, TSF and Tereos, the rating on Tereos's senior unsecured notes depends not only on the probability of default of TSF and Tereos and the potential level of debt ranking ahead of them, but also on TI's probability of default.
Due to the strong linkages between TSF, Tereos and TI, the senior unsecured note rating is derived from the consolidated group's IDR of 'BB'. Usually, for issuers rated in the 'BB' category (a transitional territory between investment-grade and highly speculative), prior-ranking debt constituting 2x-2.5x EBITDA indicates a high likelihood of subordination and lower recoveries for unsecured debt.
As we expect a recovery in EBITDA from the sugarbeet business, we believe the level of senior secured (or other form of prior-ranking) debt leverage at TSF is unlikely to rise beyond 2.0x within the next three years. We believe TSF (or Tereos) is unlikely to increase its debt ranking prior to the notes to support other group entities. In addition, existing committed debt ranking ahead of the senior unsecured notes relate to TSF's EUR400m revolving credit facility (RCF), which exclusively funds working capital needs throughout the year. Based on the company's historical intra-year working capital needs, average intra-year outstanding RCF amounts are unlikely to rise beyond 2.0x TSF's EBITDA. Therefore the senior unsecured notes are rated at the same level as the group's IDR.
KEY RATING DRIVERS FOR THE IDR
Strong Business Profile
The IDR is underpinned by Tereos's strong business profile for the 'BB' category, both in operational scope and position in commodity markets with potential for long-term growth. Due to its strong market shares and cost competitiveness, we expect the group to benefit from a post-2017 deregulated European sweeteners market. Geographic and product diversification as well as efforts to increase efficiency also support Tereos's business risk profile.
Successful Diversification
Tereos's diversification into the highly cost-competitive Brazilian sugar market and into starch and sweeteners through TI (accounted for 67% of FY16 group EBITDA) should increase resilience against the current commodity down-cycle. TI's contribution to the group's EBITDA increased 19% yoy in FY16, supported by increased production capacity and efficiency measures taken over the past few years in both the sugarcane and the starch and sweeteners divisions. Fitch expects further EBITDA growth over the next four years, even after taking into account commodity price volatility.
Although the company's starch and sweeteners unit revenues and profits (21% of FY16 group EBITDA), benefitted from low raw materials and energy costs as well as higher ethanol prices in Europe in FY16, they remain exposed to a challenging European starch and sweetener market environment characterised by stagnating demand and production overcapacity. However, the unit should see lower volatility as a result of ongoing cost savings and efficiency measures, improved raw materials and geographical diversification (in Brazil and Asia) as well as an increased sales mix towards higher-margin products.
European Sugar Price Adjustment
Similar to other European sugar processors, Tereos's European sugarbeet business has suffered a sharp contraction in profitability in the last few years. Its EBITDA dropped in FY16 to EUR146m, which is less than a third of its FY13 level, following a steep decline in EU quota sugar prices largely linked to the intervention of the European Commission in 2013.
Positively, European prices are on a recovery path due to the sector's cutback in production, leading to a rapid drop in stock-to-use ratios and supporting our expectation that in FY17 and FY18 the sugarbeet division's EBITDA should improve. We expect European sugar prices to decrease again in FY19 as they eventually converge with international prices, with the removal of the quota regime in September 2017. This reflects Fitch's conservative assumption that, while international prices have significantly recovered since mid-2015, they are unlikely to grow sustainably beyond the high level that should be reached by the European prices in FY17-FY18.
European Sugar Exports
European sugar processors currently are unable to compensate low prices with increases in sales volumes due to stagnant European demand and regulatory constraints on foreign exports until September 2017. However, as the third-largest sugarbeet player in Europe, Tereos should, once the cap is lifted, benefit from its ability to source increased volumes of sugarbeet from some of the most efficient farmers in Europe and expand its sales volumes in Europe and via exports. This volume increase should allow it to largely compensate the adverse impact on its profits (from FY19) from the likely price reduction. As a result, we project an only mild reduction of EBITDA from Tereos's sugarbeet operations in FY19 from previous year.
Expected Profit Rebound
We believe that the FY16 results represent the company's lowest EBITDA point in the current cycle and expect a profit rebound on the back of a recovery in sugar prices and efforts to enhance competitiveness in sugar processing (both in Europe and in Brazil). The group's Q117 results point to this direction. We also expect growing profit contribution from the starch and sweeteners business, due to a better product mix, larger capacity and higher industrial efficiency.
We expect Tereos's underlying profitability, measured as readily marketable inventories (RMI)-adjusted EBITDA/gross profit (thus eliminating price fluctuations), to improve from FY17. Additionally, once the current volume constraints in its sugarbeet division are removed, underlying profitability should gradually recover to pre-FY14 levels of above 40% (26% in FY16).
Expected Improvement of Credit Metrics
Tereos's RMI-adjusted funds from operations (FFO) gross leverage rose to 6.1x in FY16 (FY15: 5.0x) as a result of reduced FFO and RMI value. TI's gross leverage, on the other hand, started to improve to 6.3x from 7.5x during the same period, due to recovering profitability.
Although these levels are not consistent with the current IDR, we expect Tereos's credit metrics to improve from FY17 on a combination of a modest upturn in commodity prices, an increase in sugar export volumes and overall a strengthened business profile. We expect free cash flow (FCF) to turn neutral to positive from FY19 on a sustained basis and RMI-adjusted FFO gross leverage to decrease to around 4.0x in FY18, consistent with levels for a 'BB' rating.
Adequate Financial Flexibility
Tereos's weak credit metrics is partially mitigated by adequate financial flexibility. The latter is supported by strict financial discipline in shareholder distributions and M&A spending, adequate liquidity management and healthy RMI-adjusted FFO fixed charge cover throughout the commodity down-cycle.
In the low sugar price environment, cooperative owners have demonstrated their financial support to Tereos by accepting a sharp reduction in price complements (which Fitch treats as dividends) to EUR5m paid cash in FY15 and EUR2m in FY16 from EUR57m in FY14. We assume these will remain subdued so long as the profitability of Tereos's European sugar business remains low.
Tereos's internal liquidity score, defined as unrestricted cash plus RMI plus accounts receivables divided by total current liabilities, improved to 1.1x in FY16 from 0.7x in FY14 as management successfully lengthened the group's average debt maturity profile. This is consistent with levels for a 'BB' rating. Liquidity is further supported by comfortable access to diversified sources of external funding. We expect Tereos's RMI-adjusted fixed charge cover to have reached its low point in FY16 at 3.0x (TI: 2.7x) and to recover above 4.0x from FY18. These levels remain comfortable for the ratings.
Parent-Subsidiary Linkage
Despite limited but growing operational, financial integration and ownership, Tereos France's (TF) and Tereos's influential control as well as their legal and strategic ties with TI are very strong, making the parent and its subsidiary intrinsically linked.
The development of TI has been promoted by Tereos's cooperative owners through their financial support. This, together with Tereos's expected increase in TI's ownership, signals a strategy to allocate resources towards international diversification while enabling greater resilience against increasingly volatile commodity markets.
KEY ASSUMPTIONS
- Annual increase in revenues in the mid-single digits, driven by recovering sugar prices (in FY17 and FY18 in Europe and, more slowly, towards FY20 globally) and growing volumes from all of the group's businesses
- Gradual EBITDA margin improvement towards 12% in FY20 (FY16: 10%) driven by higher capacity utilisation rates, a better product mix, improved cost competitiveness, and to a lesser extent, recovering international sugar prices
- Average annual capex of approximately EUR390m between FY17 and FY18 as the group continues to invest in its cost base and in production capacity, before falling to EUR300m in FY20
- Price complements (dividends) paid to cooperative members to remain at modest levels.
- Mildly negative annual FCF over FY16-FY18, before turning consistently positive from FY19.
- Minor M&A disbursements including outflow for the planned minority buy-out at TI in FY17
RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating actions include:
- Strengthening of profitability (excluding price fluctuations), as measured by RMI-adjusted EBITDAR/gross profit, reflecting reasonable capacity utilisation rates in the sugarbeet business and overall increased efficiency
- At least neutral FCF while maintaining strict financial discipline
- FFO gross leverage (RMI-adjusted) consistently below 3.5x at Tereos group level and 4.0x at TI level.
Negative: Future developments that could lead to negative rating action include:
- Inability to sustainably maintain cost savings derived from efficiency programmes or excessive idle capacity in different market segments, leading to RMI-adjusted EBITDAR/gross profit remaining weak
- Inability to return consolidated FFO to approximately USD0.5bn (FY16: USD0.3bn) and to improve profitability and cash flow generation
- Reduced financial flexibility as reflected in FFO fixed charge cover (RMI-adjusted) falling below 3.0x,
- FFO gross leverage (RMI-adjusted) above 4.5x at Tereos group level (5.0x at TI level) on a sustained level
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