Fitch Downgrades Jalles' IDRs to 'B '/'A-(bra)'; Outlook Negative
KEY RATING DRIVERS
The downgrades incorporates Jalles Machado's weakening financial profile in the volatile sugar and ethanol business, due to reduced cash position combined with higher concentration of short-term debt. Systemic risk remains high for the Brazilian sugar and ethanol (S&E) sector following the default by Aralco S.A. Industria e Comercio and Virgolino de Oliveira S.A. Acucar e Alcool's (GVO) and its struggle to restructure its debt. This has made it increasingly difficult for companies to obtain long-term financing.
Fitch does not expect Jalles Machado to report a material improvement on its cash to short-term debt coverage ratio in fiscal-year 2015, despite of cash position is expected to have increased as the strategy of building up inventories in expectation of higher ethanol prices during the offseason has paid off. Jalles Machado's short-term liquidity should benefit in fiscal-year 2016 from the sale of 65% of Codora Energia Ltda (Codora) to Albioma Participacoes do Brasil (Albioma).
The Negative Outlook reflects Fitch's concerns about the medium term prospects for the Brazilian S&E sector. Prices for sugar and ethanol are expected to remain under pressure despite improvements on the ethanol industry dynamics in 2015 compared to 2014. The sector is highly exposed to weather related risks and generation of more robust operational cash flow in the new season ending March 31, 2016 will depend largely on the maintenance of favorable weather conditions as seen in fiscal-year 2015. While it is expected to help Jalles Machado to improve its cash to short-term debt position coverage, the sale of 65% into Codora somewhat weakens the company's business profile over the longer run.
Jalles Machado's ratings continue to benefit from a strong business model and robust operating margins. The company has a premium portfolio of products that includes branded organic and crystal sugar, as well as a remaining portion of its energy production. Jalles Machado benefits from fiscal incentives on the sale of sugar and ethanol and relatively low land lease costs. The ratings incorporates the company's strong agricultural performance due to its adequate investments in the cane fields, the use of irrigation over a relevant portion of its harvest area and self-sufficiency in sugar cane, which explain the lower volatility of Jalles Machado's operating cash flow generation compared to most of its peers.
Historically Weak Liquidity
Jalles Machado liquidity has been historically weak. As of Dec. 31 2014, the decrease of cash position and higher concentration of short-term debt was largely motivated by the company's strategy of building up inventories in expectation of higher ethanol prices during the offseason. The strategy paid off as ethanol prices increased in January and February 2015. While it expects Jalles Machado to have rebuilt its cash position as of March 31 2015, the cash to short-term debt coverage is expected to remain weak, keeping refinancing risks high. As of Dec. 31 2014, Jalles Machado reported cash position of BRL92 million and short-term debt of BRL324 million to yield a 0.28x coverage. This compares unfavorably with its BRL132 million cash and BRL246 million short-term debt reported for March 31 2014. For March 31 2015, Fitch expects Jalles Machado to report cash position of around BRL170 million to yield a cash to short-term debt position of less than 0.50x.
Liquidity is expected to improve in 2015 following the sale of 65% of Codora to Albioma, which should represent a cash inflow of BRL 100 million plus BRL44 million of debt transferred to the new sharehoder. Codora runs 48MW of cogeneration capacity in the State of Goias and it will be handed over back to Jalles in 20 years for a symbolic amount following the closing of the deal. Jalles Machado's main financial challenges is to keep pursuing a healthier debt maturity profile and stronger liquidity with aims at reducing refinancing risks as well the impact of the inherent sugar and ethanol price volatilities on its operating cash flow generation.
Moderate Leverage to Remain
Fitch expects that Jalles Machado will be able to keep leverage at the currently moderate levels. As of Dec. 31, 2014, the company's total adjusted debt-to-EBITDAR ratio was 3.4x, while net adjusted debt-to-EBITDAR ratio was 3.1x, well below the average of the sector. These ratios are in line with the levels reported for March 31 2014. Fitch expects total adjusted leverage to stand at below 3.5x in fiscal 2015 and 2016. As of Dec. 31, 2014, consolidated adjusted debt including obligations related to land lease was BRL1.2 billion, of which USD-denominated debt accounted for 35%. Principal and interest payments up to March 2016 are protected through derivatives. Jalles Machado's debt consisted of trade finance facilities (35%), working capital (32%); land lease agreements according to Fitch's methodology (16%); financings from the Brazilian Economic Social and Development Bank (BNDES, 11%); and others (6%).
Divestment of Cogeneration Asset
The sale of one of Jalles Machado's cogeneration assets somewhat weakens the company's business model. Codora runs 48MW of cogeneration capacity in the State of Goias that is annexed to the Usina Otavio Lage mill. In 2014/2015 season, Codora sold 97.4 GWh of energy to the national grid. Jalles Machado will keep full ownership of another cogeneration asset with capacity for 40MW and annexed to the Jalles Machado mill. The company is expected to generate 134 GWh in 2015/2016 including its remaining 35% stake into Codora, down 28% from the 185GWh generated by these two assets in the 2014/2015 season.
According to the terms and condition of the agreement signed with Albioma, Jalles Machado will repurchase Codora in 20 years for a symbolic amount. The agreement also includes Jalles Machado's commitment to increase crushing capacity at Usina Otavio Lage to 2.2 million tons by 2018/2019 from the current 1.7 million tons. The sale of energy from cogeneration has been contributing to Jalles Machado's robust operating margins and helping the company to reduce the impact of the inherent sugar and ethanol price volatilities on the company's operating cash flow generation.
EBITDAR Margins Above Industry Peers
Jalles Machado offers a differentiated product portfolio that contributes to EBITDAR margins within a range of 66% and 75%, which compare favorably with the industry average. As of the LTM ended December 31 2014, net revenues increased by 14% to BRL507 million and EBITDAR amounted to BRL353 million, at a 70% margin. The company's premium portfolio of products includes the sale of branded organic and crystal sugar, the latter holding relevant market share in Brazil's Northern and Northeastern retail markets. Prices for both products command large premiums compared to VHP sugar. Product mix also includes sale of hydrous, anhydrous and industrial ethanol. In fiscal year 2014, Jalles Machado's net revenues were broken down as follows: hydrous ethanol (29%), crystal sugar (24%), anhydrous ethanol (17%), organic sugar (15%), energy (7%), raw sugar (6%) and others with the balance.
High operating margins also reflect the company's fiscal incentives provided by the State of Goias on the sale of sugar and ethanol. In the nine months through Dec. 31 2014, tax incentives added BRL24 million to Jalles Machado's EBITDA. The company's low land lease costs, well below the average of the State of Sao Paulo, also play a role. The self-sufficiency in sugar cane has a positive accounting impact on Jalles Machado's margins. As spending on the cane fields is accounted for as capital expenditure rather than cost, the higher the share of own cane in the mix, the larger the capital expenditure and the lower the impact on EBITDAR.
Positive FCF Expected for Fiscal Year 2016
Jalles Marchado's cash flow from operations (CFFO) should continue to reflect weak prices for sugar and ethanol in fiscal year 2016. The full utilization of the company's mills and recent investments in the expansion of its harvest area should help to reduce the impact of this challenging scenario. The company is expected to crush 4.4 million tons of sugar cane, favorably comparing to 4.2 million tons reported for fiscal 2015. It is also foreseen the company's two units to operate near 100% of maximum capacity and its cane fields to generate excess sugar cane production of over 200,000 tons in fiscal year 2016. The company has just come out from an investment program that increased its harvest area to 47,782 hectares at the end of fiscal year 2015 from 29,000 hectares in fiscal year 2010.
Jalles Machado's FCF should turn positive in fiscal year 2016 and remain in surplus in the years that follow. In the LTM ended December 31 2014, Jalles Machado posted FCF at break-even compared to negative amount of BRL37 million in fiscal 2014. In the latest 12 months (LTM) ended on December 31, 2014, Jalles Machado reported robust CFFO of BRL206 million, flat compared to fiscal 2014.
KEY ASSUMPTIONS
--Crushed volumes of 4.4 million tons in 2015/2016 and capacity utilization around current levels for 2015/2016 and next crop years.
--Additional CAPEX needed to increase Usina Otavio Lage crushed volumes to 2.2 million tons by 2018/2019 from the current 1.7 million tons;
--Product mix relatively unchanged compared to the 2014/15 season and maintenance of high premiums for organic sugar;
--Average sugar prices at USD14 cents/pound in 2015/2016, USD16 cents/pound in 2016/2017 and flat at USD17 cents/pound from 2017/2018 on;
--Domestic ethanol prices keeping the historical correlation with international sugar prices..
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a negative rating action include:
--Adjusted leverage, measured by net adjusted debt to EBITDAR, of 4.0x or above on a sustainable basis;
--Cash plus CFFO over short term debt below 1.0x.
Although unlikely in the near term, future developments that may, individually or collectively, lead to a positive rating action include:
--Net adjusted leverage to levels of 3.0x or below, sustainably;
--Cash to short-term debt equal to or above 1.0x.
--More favorable business profile for the sugar and ethanol sector.
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