SAO PAULO--()--Fitch Ratings has affirmed at 'B' the foreign and local currency Issuer Default Ratings (IDRs) of Virgolino de Oliveira S/A Acucar e Alcool (GVO) and Virgolino de Oliveira Finance S/A (Virgolino Finance). The Rating Outlook is Stable. A full list of GVO's ratings follows at the end of this press release.
GVO and Virgolino Finance's ratings reflect the group's leveraged capital structure and tight liquidity position. The ratings further incorporate the group's exposure to the cyclicality of the sugar and ethanol commodities' price cycle, as well as the volatility of cash flow generation, exposing the group to refinancing risk. They also reflect the exposure of GVO's sugarcane production business to volatile weather conditions, foreign currency risk relative to a portion of its debt; and the ethanol industry dynamics, which are strongly linked to Brazil's regulated gasoline prices and related government energy policies. The ratings benefit from GVO's adequate business model and the geographical location of its production units. The ratings also reflect positively GVO's strategic shareholding position in Copersucar and the long term business partnership between the two companies.
GVO's main challenge is to reduce leverage through improved operational cash flow in the next two to three years. The ratings could be under pressure in case the expected deleveraging does not materialize.
Adequate Business Profile Enhanced by Co-operation with Copersucar
GVO has an adequate business profile, based on its favorable location, diversified production base and operational flexibility. The company also benefits from the favorable prospects related to ethanol consumption in the country and Brazil's significant presence in the global sugar trade.
GVO enjoys competitive advantages linked to its participation in Copersucar which allows it to maintain EBITDA margin above the industry average. The group benefits from Copersucar's robust scale, which results in mitigated demand risks, lower logistics costs and better stability in the company's collection flow. GVO also benefits from less restrictive access to liquidity during challenging operating scenarios when compared to other peers in the agribusiness, due to the credit lines provided by Copersucar. Copersucar's large scale business accounts for approximately 18% of sugar and ethanol sales in the Central South region of Brazil and 10% of the sugar international market, making it an important price making agent. Copersucar has 48 partner mills with a combined sugar cane crushing capacity of around 115 million tons per year and also counts on sales contracts with non-partner mills, in a lesser extent.
High Leverage, Expected to Decline
In the LTM ended Oct. 31, 2012, GVO's consolidated net adjusted debt/EBITDAR ratio, considering Copersucar dividends, was 6.2x, above Fitch's expectations of around 4.5x for this period. This higher leverage resulted from the combination of pressured FCF ? the consequence of higher capital expenditures during the last harvest, which included crop expansion to increase the contribution of owned sugar cane supply ? and the negative impact of the FX variation on GVO's debt. Additionally, the October 2012 figures reflect the middle of the crop period, when working capital needs were higher compared to the end of the harvest. Excluding advances from Copersucar backed by sugar and ethanol inventories (BRL257.8 million), GVO's net adjusted debt/EBITDAR would be 5.3x for the same period.
Fitch expects GVO's CFFO to increase in the coming years, supported by a higher utilization of its industrial capacity, which should allow it to reduce leverage within the next couple of years to between 4.3x and 4.6x, including the advances from Copersucar, levels more appropriate for the rating category. These estimates assume average sugar international prices of USD20 cents/ pound for the next years and stable ethanol prices compared to current levels.
Cost Savings, Scale Benefits and Risk Management Support Related to Copersucar
GVO transfers 100% of its production to Copersucar, through a long term exclusivity contract, mitigating demand risk. Prices for its products are linked to the average sugar and ethanol market prices plus a premium (Esalq+2%). The premium is possible due to logistics savings and scale gains obtained through the partnership with Copersucar. GVO is responsible for the agricultural activities and for the sugar and ethanol production, while Copersucar is responsible for all commercial activities and associated logistics, as well as for the implementation of hedging policies.
Copersucar remunerates GVO based on the realized production on a monthly basis during the year, independently of the moment the sale to the final customer occurs. This translates to a higher flexibility in GVO's working capital management compared to other companies that face seasonality in their activities. GVO's businesses are exposed to the volatility of the sugar and ethanol prices. However, the risks of future sales operations through derivatives transactions and eventual margin calls remain under Copersucar's responsibility.
Tight Liquidity Supported By Credit Line from Copersucar:
As of Oct. 31, 2012, GVO reported a cash position of BRL150 million, which covered only 24% of its short-term adjusted debt. However, Copersucar provides to GVO a significant working capital financing line, in the amount of up to 40% of its annual revenues, equivalent to approximately BRL400 million, which enhances financial flexibility. This credit line is subject to certain limits in terms of revenues and it is linked to guarantees on inventories and/or bank guarantees. This facility is an important liquidity source for GVO, especially in periods of more restrictive access to credit.
Moderate Exposure to FX Fluctuations:
GVO's debt profile is moderately exposed to foreign exchange movements with 45% of debt denominated in USD. Although the company does not maintain protection through derivatives, the currency exposure is partially mitigated by the fact that the price for GVO's products is linked to the dollar.
As of Oct. 31, 2012, consolidated adjusted debt including obligations related to leased land was BRL2.2 billion. The debt comprised of two international notes issuances (45%); loans granted by Copersucar (17%); financings from the Brazilian Economic Social and Development Bank (BNDES, 10%); export prepayment transactions (7%) and others (21%).
Key Rating Drivers:
Negative rating actions could be driven by GVO's failure to deleverage and/or lower than expected operational cash flow generation and deterioration of its operating margins. Improvement in the group's liquidity position coupled with a longer and more manageable debt maturity profile with lower leverage levels, could lead to a positive rating action.
Fitch affirms GVO and Virgolino Finance's ratings as follows.
--Long-term national scale corporate rating at 'BBB(bra)';
--1st debenture issuance due 2014 at 'BBB(bra);
--Foreign and local currency IDR at 'B'.
--Foreign and local currency IDR at 'B';
--Senior unsecured notes at 'B/RR4'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 08, 2012);
--'National Ratings Criteria' (Jan. 19, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
National Ratings Criteria