OREANDA-NEWS. Fitch Ratings has downgraded Biosev S.A.'s (Biosev) long-term foreign and local currency Issuer Default Rating (IDR) to 'B+' from 'BB-' and its long-term national scale rating to 'A-(bra)' from 'A+(bra)'. The Rating Outlook is revised to Stable from Negative.

KEY RATING DRIVERS

The rating downgrade incorporates Biosev's challenges to achieve positive free cash flow (FCF) and reduce leverage to levels compatible with the previous IDR. While the scenario for sugar and ethanol prices have improved recently and larger crushed volumes are expected for Biosev in the ongoing crop season, the combination of Biosev's heavy agricultural and industrial investments needed to improve agricultural yields and reduce idle capacity of its mills with high interest and FX rates are expected to hold back expected improvements of its FCF and leverage ratios.

Positively, Biosev has demonstrated it retained its capacity to tap medium- and long-term financings with financial institutions and the parent company, as well as presents satisfactory cash to short-term debt coverage ratio at the end of fiscal year despite the sector's increased refinancing risks in 2015. The ratings continue to reflect Biosev's large crushing and storage capacity combined with a differentiated business model built on clusters. Fitch also considers as positive its affiliation with Louis Dreyfus Group (LD Group) as this relationship brings operational and financial benefits to the company on top of its capacity to take advantage of LD Group's proven expertise in the global agricultural commodities market.

Negative FCF to Remain

Fitch expects Biosev to report negative FCF over the 2016/2017 and 2017/2018 seasons due to the investments needed to improve productivity of its cane fields and capacity utilization at its mills. While Fitch expects Biosev's cash flow from operations (CFFO) to benefit from higher sugar and ethanol prices and larger crushed volumes in the ongoing crop season, Fitch forecasts negative FCF of around BRL300 million in fiscal year ending March 31, 2016. Fitch expects a 50% increase in CFFO in fiscal 2017 due to larger volumes and better prices, though higher spending on planting and crop care is expected to increase the company's investments by 20%, leaving FCF in negative territory at over BRL200 million.

In the latest 12 months (LTM) ended Dec. 31, 2015, funds from operations (FFO) and CFFO amounted to BRL419 million and BRL761 million, respectively, which compared to BRL555 million and BRL528 million reported for the same period of the previous year. In the latest 12 months (LTM) ended Dec. 31, 2015, CFFO was not enough to cover the company's capex of BRL1.1 billion, leading to negative FCF of BRL321 million.

Increased Leverage

The BRL devaluation and negative FCF generated did not allow Biosev to substantially reduce net adjusted leverage ratios in fiscal 2016. In Fitch's view, the company's capacity to deleverage will depend on its ability to benefit CFFO from a combination of higher yields and capacity utilization at its mills with the maintenance of favorable sugar and ethanol prices. As of Dec. 31, 2015, the company reported net adjusted debt to EBITDAR of 5.1x comparing favorably with 5.3x reported for Dec. 31, 2014. In the nine months ended Dec. 31, 2015, the company reported net FX losses of BRL700 million. Biosev's USD-denominated debt accounts for 75% of its total adjusted debt.

Large-Scale Not Benefiting Performance

Biosev's large scale has not yet benefited the company's operational metrics. While Fitch expects Biosev to report higher crushed volumes and capacity utilization in 2015/2016, Fitch expects the company to run its operations with relevant idle capacity compared to peers of similar size. The company closed the nine months through Dec. 31, 2015, with average agricultural yield of 82.7 ton/ha, comparing unfavorably with the average 85.8 ton/ha reported in Brazil's Center South. In terms of sugar content the company reported 129 kilos per ton, a 0.4% increase year-over-year while the Center South region of Brazil posted a 4% decline to 131 kilos per ton.

Biosev has the second largest crushing capacity of S&E global industry (36.4 million tons spread over 11 mills) with prominent storage capacity for both products. Its hefty storage capacity allows the company to wait for more favorable moments to sell its products. The organization of its industrial and agricultural assets around clusters generates operating synergies as well as secures an adequate supply of sugar cane to its mills, helping to fend off potential competitors by imposing high entry barriers. The mills and cane fields are located in regions with access to good quality soil, being near Brazil's main consumer centers and having efficient logistics access to port terminals. The company produces a broad portfolio of products and some of its plants are able to export ethanol to the United States.

Fitch expects no acquisitions from Biosev in the short and medium term. After a series of acquisitions, the agency expects the management to improve profitability of the current assets before moving to inorganic growth opportunities as it was in the past. Fitch views the profitability strategy at the current moment as positive and supportive to the current ratings.

Positive Affiliation with the LD Group

The affiliation with LD Group translates into positive synergies and gives Biosev access to a broad range of data and information on the current shape of the S&E global markets, inventory and demand levels for both products, price trends, and the performance of foreign currencies across the globe, among others. The LD Group is one of the main clients for the sugar produced by Biosev. The adoption of efficient risk management practices has been reflecting positively on the attractive level of hedged sugar prices and has also helped to reduce the impact of the recently FX volatility. Support from LD also comes in the form of advances received from the Group for future delivery of very high polarization (VHP) sugar. These proceeds are used in the financing of Biosev's working capital needs. This debt has lower refinancing risk when compared to regular bank debt due to its inter-company nature. Typically, intra-group sales amount to a range of 700,000 tons to 900,000 tons of VHP sugar per year.

KEY ASSUMPTIONS

--Increase in crushed volumes of 6% in fiscal 2017 and 2% from fiscal 2018 onwards.
--Increases in total recoverable sugar in tandem with the expected growth in crushed volumes. Fitch projects production mix bending towards sugar over the next crop years to reach 55% sugar and 45% ethanol.
--International sugar prices forecast to remain flat at USD15 cents/pound during the whole projected period, which should translate into average sugar prices of BRL1,400/ton.
--Increases in ethanol prices keeping pace with the expected inflation rate in the period.
--Increase of 20% in capex in fiscal 2017 primarily on higher spending on planting and crop care. Fitch forecasts annual increases of 7% from fiscal 2018 on.

RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a negative rating action include:

--Any demonstration of diminishing support from LD Group would be viewed negatively by Fitch
--Net adjusted debt to EBITDAR ratio of 4.5x or above on a sustainable basis
--Cash plus CFFO over short-term debt below 1.0x.

Future developments that may, individually or collectively, lead to a positive rating action include:

--Cash plus finished product inventories at market value to short-term debt equal to or above 1.5x.
--Net adjusted debt to EBITDAR ratio of 3.0x or below on a sustainable basis
--Positive FCF generation.

LIQUIDITY

Fitch expects Biosev to report a cash position of over BRL2 billion and short-term debt below that level on March 31, 2016 following the much higher ethanol prices seen during the fourth quarter of fiscal 2016 (4Q16), inter-harvest period for the Brazilian sugar cane industry. As of Dec. 31, 2015, Biosev reported inventories of over BRL1.1 billion comprising 372,000 tons of sugar and 272 million liters of ethanol, up 1.3% and down 42%, respectively, from the same period of the previous year. The 45% increase in average market hydrous ethanol prices seen during the 4Q16 compared to the same period of previous year fully offsets the lower inventories position in the comparable period.

Biosev has retained access to medium- and long-term finances with its parent company and financial institutions and has managed to roll over some of its short-term debt, also contributing to the satisfactory liquidity position expected to be posted for March 31, 2016. As of Dec. 31, 2015, Biosev reported cash position of BRL983 million unfavorably comparing with short-term debt of BRL2.2 billion to yield a 0.45x coverage. As of Dec 31 2014, the company reported a cash to short-term debt coverage of only 0.10x. At the end of fiscal 2015, Biosev reported a cash position of BRL2 billion and short-term debt of BRL1.8 billion.