Fitch Downgrades Tonon's IDRs to 'B-' on Rating Watch Negative

SAO PAULO--()--Fitch Ratings has downgraded Tonon Bioenergia S.A's (Tonon) foreign and local currency Issuer Default Ratings (IDRs) to 'B-' from 'B'. Fitch has also downgraded to 'B-/RR4' from 'B/RR4' the ratings on the company's USD300 million unsecured notes due 2020 and the USD230 million secured notes due 2024 issued by Tonon's fully-owned subsidiary Tonon Luxembourg S.A.. The ratings are currently on Watch Negative.

KEY RATING DRIVERS

The downgrade is based on Tonon's weaker financial profile in the volatile sugar and ethanol business, underpinned by higher short-term debt concentration, generation of negative free cash flows (FCF) and increased leverage ratios. Systemic risk has increased in 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) struggle to restructure its debt, making it increasingly difficult for companies to obtain working capital financing and post comfortable cash to short-term debt coverage ratios.

The Watch Negative reflects Fitch's concerns about Tonon's escalating debt refinancing risks. The company has been rolling over its maturing debt with short-term debt as availability of medium and long-term unsecured loans has become scarcer for most Brazilian S&E companies. Tonon does not own land properties to collateralize new financings, which makes access to longer tenor debt more challenging. Tonon still faces a stressed scenario for sugar and ethanol prices, which adds challenges to the company to strengthen its operational cash flow generation, even with the improvements on the ethanol industry in 2015 compared to 2014 and the benefits of the weaker BRL for the competitiveness of the Brazilian sugar abroad. The increase in crushed volumes and generation of more robust operational cash flow in the new season ending March 2016 will depend largely on the maintenance of favorable weather conditions as seen in early 2015.

Higher Refinancing Risk

Tonon's liquidity is under pressure as short-term debt is increasing at a higher pace than the cash position. The company has been finding it difficult to roll over its maturing obligations with new long-term loans as bank lending activity in the sector has been focused on short-term borrowings. The company does not own land properties against which to borrow new medium or long-term loans, which reduces its refinancing prospects and makes the company dependent on the availability of short-term credit lines. As of Dec. 31 2014, Tonon's cash position of BRL159 million compared unfavorably with short-term debt of BRL257 million to yield a 0.62x coverage ratio. In the previous quarter the company had reported cash and short-term debt positions of BRL148 million and BRL154 million, respectively, yielding a 0.96x coverage ratio.

Tonon's higher refinancing risks are also underpinned by the generation of negative free cash flow (FCF). The company's cash flows have been pressured by a large expansion capital expenditure program that raised crushing capacity to 9.4 million from 8.2 million tons of sugar cane. Investments were concentrated primarily on the expansion of the Vista Alegre Unit in the state of Mato Grosso do Sul, whose crushing capacity went to 3.7 million tons from 2.5 million tons. In the last 12 months ended Dec. 31 2014, the company posted cash flow from operations (CFFO) at BRL304 million, which compared unfavorably to capital expenditures at BRL452 million to leave FCF at a negative BRL147 million.

Fitch expects Tonon's FCF to remain negative in the next two years, even with a reduction on capital expenditures to BRL260 million for fiscal year 2016, after the end of the capacity expansion. While strongly attenuated by the recent depreciation of the BRL, the rebound of international sugar prices is taking much longer than expected to materialize and it is holding back a more prominent recovery of S&E companies' operating cash flows. A series of government measures both at the federal and state levels have improved the prospects for the ethanol industry, but the positive short-term impact is expected to be limited.

Increased Leverage and FX Risk:

Tonon presents a weak financial profile underpinned by its levered capital structure in a volatile sector. The company's total adjusted debt as per Fitch's internal criteria amounted to BRL2.3 billion as of Dec. 31 2014, unfavorably comparing to BRL1.8 billion in March 31 2014. The increase was due to the issuance by Tonon Luxembourg of USD230 million senior secured notes in May 2014, and the BRL depreciation, which added BRL276 million to Tonon's total debt figure in the 9 months ended Dec. 31, 2014. In the last 12 months ended Dec. 31, 2014, the company's consolidated net adjusted debt/EBITDAR ratio was 4.9x compared with 4.0x in March 2014 and 3.0x in March 2013. Fitch expects Tonon's net adjusted debt to EBITDAR to reach over 6.0x in March 2015 and stay above 5.0x in March 2016.

The company is highly exposed to foreign exchange risk as USD-denominated debt accounted for 75% of its total adjusted debt while exports accounted for 53% of revenues in the last 12 months ended Dec. 31, 2014. The company's USD-denominated debt is not protected by hedging instruments. At the same date, Tonon's total adjusted debt outstanding comprised the USD300 million Unsecured Senior Notes due 2020 (33%); USD230 million Senior Secured Notes due 2024 (25%); land lease agreements as per Fitch's internal criteria (24%), exports pre-payments and other trade finance facilities (11%); working capital lines (6%) and others with the balance.

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 recently concluded investments that raised crushing capacity by 1.2 million tons to 9.4 million tons of sugar cane per year, distributed in three industrial units located in the states of Sao Paulo and Mato Grosso do Sul. Tonon's sugar output is mostly exported, while around 80% of its ethanol production is sold to the domestic market. Own sugar cane accounts for around 75% of its total origination needs and the company does not own cogeneration assets.

KEY ASSUMPTIONS

--Crushed volumes of 8 million tons in 2015/2016 and gradual increases of 2% thereafter;

--Mix relatively unchanged at 56% sugar and 44% ethanol for the projected period;

--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

Tonon's inability to improve its liquidity risk in the coming months could lead to a negative rating action. A positive rating action is unlikely in the short to medium term.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014);

--'National Scale Ratings Criteria' (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=749393

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=982559

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Contacts

Fitch Ratings
Primary Analyst
Claudio Miori
Associate Director
+55-11-4504-2207
Fitch Ratings Brasil Ltda
Alameda Santos, 700 - 7 andar
Sao Paulo, sp CEP 01418-100
or
Secondary Analyst
Alexandre Garcia
Associate Director
+55-11-4504-2616
or
Committee Chairperson
Ricardo Carvalho
Senior Director
+55-21-4503-2627
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Claudio Miori
Associate Director
+55-11-4504-2207
Fitch Ratings Brasil Ltda
Alameda Santos, 700 - 7 andar
Sao Paulo, sp CEP 01418-100
or
Secondary Analyst
Alexandre Garcia
Associate Director
+55-11-4504-2616
or
Committee Chairperson
Ricardo Carvalho
Senior Director
+55-21-4503-2627
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com