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Fitch Affirms Jalles Machado's IDRs at 'B+'; Outlook Stable
April 11, 2017 / 8:48 PM / 5 months ago

Fitch Affirms Jalles Machado's IDRs at 'B+'; Outlook Stable

(The following statement was released by the rating agency) SAO PAULO, April 11 (Fitch) Fitch Ratings has affirmed Jalles Machado S.A.'s (Jalles Machado) Long-Term Foreign and Local Currency Issuer Default Rating (IDR) at 'B+' and its long-term National scale rating at 'A-(bra)'. The Rating Outlook is Stable. KEY RATING DRIVERS The ratings reflect Fitch's expectations that Jalles Machado will keep generating resilient cash flow from operations (CFFO), with moderate leverage and robust operating margins. Nevertheless, we consider that the company's ability to access different sources of funding should continue to be limited and consistent with the current IDR, as the Brazilian sugar and ethanol (S&E) industry faced a recent period of stress with many players going into default. The intrinsically high volatility in this sector is a permanent risk that is incorporated into our analysis. Jalles Machado's business model is above average when compared to peers and should strengthen with the construction of a new sugar factory. The company will then be able to benefit from a premium portfolio of products that includes branded organic and crystal sugar. The company's energy production capacity through its biomass thermal plants also adds to the credit profile due to its more stable cash flow. Fitch expects Jalles Machado to present a positive free cash flow (FCF) over the next four years. Nevertheless, investments in the new sugar factory and in the cane fields to raise the company's crushing capacity to 5 million tons from 4.6 million tons are expected to have a negative impact on cash flow in fiscal 2017 and 2018. Positive FCF Should Persist Fitch forecasts FCF at close to breakeven in fiscal 2017 and of around BRL40 million in fiscal 2018. The company reported positive FCF of BRL18 million in the last 12 months (LTM) ended Dec. 31, 2016. Cash flow from operations (CFFO) amounted to BRL253 million in the LTM ended Dec. 31, 2016, down 38% from BRL410 million reported in fiscal 2016, but sufficient to cover capex of BRL235 million. Jalles Machado's weaker cash flow reflected the 18% drop in crushed volumes that followed the worst weather conditions in decades, which were partly offset by higher sugar concentration, industrial yields and the company's flexibility to maximize production of high-value-added products. FCF in fiscal 2017 and 2018 will be pressured by investments in the new sugar factory annexed to the Usina Otavio Lage (UOL) mill, in cane field productivity, and to raise UOL's crushing capacity to 2.2 million tons from 1.8 million tons. Fitch expects that more favorable weather conditions in 2017 will bring agricultural yields back to historical levels and contribute to raising crushed volumes to over 4.3 million tons in the 2017/2018 crop season. The company crushed 3.8 million tons of sugar cane in the 2016/2017 season, comparing unfavorably with the record 4.6 million tons in the previous season. While international sugar prices have receded sharply recently to less than USD17 cents/pound from USD20 cents/pound in the beginning of the year, Jalles Machado's attractively hedged sugar prices and improved crushed volumes are expected to contribute to the positive FCF in 2017/2018. The high uncertainty surrounding sugar and ethanol prices for the following seasons is an important issue in our analysis that limits the IDRs. Moderate Leverage Fitch expects Jalles Machado to report net adjusted leverage at around 2.0x in fiscal 2017, flat compared to March 31, 2016, and at 1.7x in fiscal 2018, well below the sector's average. The company posted net adjusted leverage of 2.2x as of the LTM ended Dec. 31, 2016. Fitch's projected decline in net leverage ratios in the ongoing crop season reflects the expectation of positive FCF for the fiscal year and the recent strengthening of the BRL against the USD compared to Dec. 31, 2016. As of Dec. 31, 2016, consolidated adjusted debt including obligations related to land lease was BRL1.4 billion, of which USD-denominated debt accounted for 20%. Principal and interest payments up to March 2018 are protected through derivatives. Strong Business Model Fitch believes the new sugar factory will strengthen Jalles Machado's business model. The company will already be able to take advantage of the attractively hedged sugar prices in the 2017/2018 season. Prices for the new sugar production are already hedged and incremental EBITDA on a pro forma basis is estimated at over BRL60 million. The new factory will balance the company product mix towards 44% sugar / 56% ethanol (currently 34% sugar / 66% ethanol), noting that profitability of the sweetener has historically been above that of the biofuel. Jalles Machado offers a differentiated product portfolio that contributes to average EBITDAR margins of 74%, which compare favorably with the industry average. As of the LTM ended Dec. 31, 2016, net revenues increased by 6% to BRL760 million and EBITDAR amounted to BRL588 million, at a 77% 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 Very High Polarizaton (VHP) sugar. Product mix also includes sale of hydrous, anhydrous, industrial ethanol and sanitizers, with the domestic ethanol market becoming more volatile following Petroleo Brasileiro S/A's (Petrobras) new fuel pricing policy. High operating margins also reflect the fiscal incentives provided by the State of Goias on the sale of sugar and ethanol. In the nine months through Dec. 31, 2016, tax incentives added BRL27 million to Jalles Machado's EBITDAR. 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 owned cane in the mix, the larger the capital expenditure and the lower the impact on EBITDAR. KEY ASSUMPTIONS --Sugar prices at USD19 cents/pound in 2017/2018 and average prices of USD17 cents/pound from then on; --The combination of oil prices and the FX rate will lead Petrobras to keep increasing domestic gasoline prices, paving the way for a gradual increase in hydrous ethanol prices; -- Average crushed volumes of 4.4 million tons in the projected period; --Additional capex needed to put the new sugar factory on stream and to increase Usina Otavio Lage crushed volumes to 2.2 million tons by the 2018/2019 season from the current 1.8 million tons; --Higher presence of sugar in the product mix relative to historical levels due to the coming on stream of the new sugar factory and maintenance of high premiums for organic sugar. RATING SENSITIVITIES Future developments that may, individually or collectively, lead to a negative rating action: --Net adjusted debt to EBITDAR of 3.5x or above on a sustainable basis; --Cash plus CFFO over short-term debt below 1x. Future developments that may, individually or collectively, lead to a positive rating action: --Improving liquidity for the Brazilian S&E industry; --Cash plus finished product inventories at market value-to-short-term debt equal to or above 2x. LIQUIDITY Fitch expects Jalles Machado to report cash near BRL300 million and cash to short-term debt at around 1.0x in fiscal 2017. This would compare favorably with cash to short-term debt coverage of 0.9x as of fiscal 2016. The maintenance of a weak cash position in the third quarter of fiscal 2017 was largely motivated by the company's strategy of building up inventories in expectation of higher sugar and ethanol prices during the offseason. While its cash and short-term debt positions amounted to BRL198 million and BRL383 million, respectively, for the 3Q17 the company reported robust inventories position of BRL301 million at market values. The strategy paid off, as crystal sugar and ethanol prices increased substantially in the last quarter of fiscal 2017. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: --Long-Term Foreign Currency Issuer Default Ratings (IDRs) at 'B+'; --Long-Term Local Currency IDR at 'B+'; --Long-Term National Scale Rating at 'A-(bra)'. Contact: Primary Analyst Claudio Miori Associate Director +55-11-4504-2207 Fitch Ratings Brasil Ltda. Alameda Santos,700 - 7th floor Cerqueira Cesar - Sao Paulo - SP Secondary Analyst Alexandre Garcia Associate Director +55-11-4504-2616 Committee Chairperson Mauro Storino Senior Director +55-21-4503-2625 Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: elizabeth.fogerty@fitchratings.com. 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