Fitch Affirms Tonon's IDR at 'B'

SAO PAULO--()--Fitch Ratings has affirmed the foreign and local currency Issuer Default Ratings (IDRs) of Tonon Bioenergia S.A at 'B'. Fitch has also affirmed at 'B' the rating for the company's USD300 million senior unsecured notes due 2020. A Recovery Rating of 'RR4' has been affirmed for the bond. The Rating Outlook for Tonon is Stable.

KEY RATING DRIVERS

Tonon's ratings reflect the limited scale of its businesses and the company's exposure to the cyclical sugar and ethanol industry, which is characterized by strong price volatility and risks inherent to the agribusiness sector. Tonon's ethanol business is also exposed to industry dynamics with prices linked to Brazil's regulated gasoline prices. The government energy policies can potentially impact the profitability of the ethanol business. The ratings also incorporate Tonon's sizeable investment plans for the upcoming years, which should pressure the company's free cash flow (FCF).

Average Business Position

Tonon is a medium-sized sugar and ethanol company in a fragmented commodity sector in which scale is relevant and volatility is high. The company has 8.2 million tons of crushing capacity per year, distributed in three industrial units located in the states of Sao Paulo and Mato Grosso do Sul. Capital expenditures should increase crushing capacity to 9.4 million tons, while maintaining flexibility to produce up to approximately 60% of sugar or ethanol. Tonon's sugar production is mostly exported while around 80% of its ethanol production is sold to domestic market.

Accretive Paraiso Bioenergia Acquisition, Limited Credit Impact

Tonon acquired Paraiso Bioenergia in March, a 2.5 million-ton mill located in the State of Sao Paulo for BRL170 million, of which BRL 120 million was paid via a share swap. The acquisition was strategically positive for Tonon as it increases its business scale and should allow the capture of synergies, given the proximity of its main unit to Paraiso's industrial mill. This acquisition should improve the company's efficiency. It should also help the company secure sufficient sugar cane in the State of Sao Paulo and increases Tonon's presence in refined sugar, whose prices carry a premium over VHP's (Very High Polarized). Fitch also notes that Paraiso's EBITDA margins are lower than those registered by Tonon, indicating room for improvement. With this transaction, Tonon will be able to increase its crushing capacity by 44%, reaching 8.2 million tons of sugar cane in the 2013/2014 harvest period.

Sizeable capex program pressuring Free Cash Flow

Fitch expects Tonon's FCF to be negative in the next two years. Up to the 2015/2016 harvest period, total investment should reach approximately BRL710 million, primarily in the expansion of the Vista Alegre Unit in the state of Mato Grosso do Sul. Investments in the expansion of Vista Alegre's cane fields should be relevant as virtually all of Vista Alegre's sugar cane is self-supplied. This plant should have its capacity raised to 3.7 million tons from 2.5 million tons by the beginning of the 2015/2016 season and Tonon's total capacity will grow to 9.4 million tons from the current 8.2 million tons. In the LTM ended Sept. 30, 2013, Tonon's free cash flow (FCF) was negative BRL67 million. If you include, Paraiso Bioenergia they would have been negative by BRL38 million. The pro forma capex figures were BRL326 million for the last 12 months through Sept. 30 2013. In the LTM ended Sept. 30, 2013, on a pro forma basis, Tonon's revenues were BRL876 million, while its EBITDA was BRL344 million.

Leverage Increasing

Fitch expects the company will be able to manage its net leverage at an adequate level of below 3.0x in the medium term. On a pro forma basis, considering 12 months of Paraiso's operations, Tonon's net leverage has increased to 2.9x for the latest 12 months (LTM) ended Sept. 30, 2013, compared to 2.5 in March 2013. Fitch's projections consider mid-cycle prices of sugar and ethanol, assuming USD20 cents per pound for the next harvest periods. The company's results will ultimately depend on the company's ability to complete the necessary investments and increase its capacity utilization within the expected schedule, in order to avoid pressure on its capital structure.

Satisfactory liquidity

Tonon reported manageable debt repayment profile and satisfactory liquidity as of Sept. 30 2013. Tonon has conservatively maintained part of the USD300 million seven-year unsecured notes in January 2013 in cash. The sale of cogeneration assets to Energia for BRL150 million and the closing of a syndicated long-term loan of BRL250 million in the third quarter of 2012 also played a role in maintaining a strong cash position. As of Sept. 30 2013, the company's cash reserves amounted to BRL253 million and exceeded by 15% its total short-term debt (as per Fitch's internal methodologies). Tonon's long-term debt accounted for 85% of the on-balance gross debt outstanding as of Sept. 30 2013, of which 54% will fall due in January 2020 (the notes).

Rating Sensitivities

A negative rating action could be triggered if the company's liquidity deteriorates and/or if leverage increases on a consistent basis. A downgrade will also occur if the expected improvement of Cash Flow from Operations (CFO) does not materialize.

A positive rating action will occur if leverage goes down on a consistent basis and if the company manages to maintain or improve liquidity.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug.5, 2013);

--'National Ratings - Methodology Update' (Oct. 31, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

National Scale Ratings Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=720082

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=812581

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Contacts

Fitch Ratings
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Claudio Miori, +55-11-4504-2207
Associate Director
Fitch Ratings Brasil Ltda
Alameda Santos, 700 - 7 andar, Sao Paulo, sp CEP 01418-100
or
Secondary Analyst
Alexandre Garcia, +55-11-4504-2205
Associate Director
or
Committee Chairperson
Ricardo Carvalho, +55-21-4503-2627
Senior Director

Sharing

Contacts

Fitch Ratings
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Claudio Miori, +55-11-4504-2207
Associate Director
Fitch Ratings Brasil Ltda
Alameda Santos, 700 - 7 andar, Sao Paulo, sp CEP 01418-100
or
Secondary Analyst
Alexandre Garcia, +55-11-4504-2205
Associate Director
or
Committee Chairperson
Ricardo Carvalho, +55-21-4503-2627
Senior Director