Investors less sweet on Brazil's sugar sector

Thu Feb 6, 2014 3:25pm EST

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Feb 6 (IFR) - Troubles across the Brazilian sugar sector are coming to a head, with investors keeping a nervous eye on troubled credit Aralco - which has been living from coupon payment to coupon payment, and has another coming due in May.

Multi-year lows in sugar prices have exacerbated Aralco's woes amid talk of a restructuring, and the dark mood has even spilled over to sugar bonds in Peru, as companies burn through cash to service their debt.

Aralco's 10.125% 2020s were trading Thursday at default levels of around 15 cents on the dollar - another sharp fall from earlier in the year, when they were already down to 45.00 area.

Fitch and S&P recently downgraded Aralco to CCC and B- respectively, citing worries over the company's short-term liquidity and subsequent refinancing risks.

The next payment on the instrument is due May 7, and after hiring BR Virtus Partners as an advisor in January, talk has been mounting that a default is on the cards.

Fitch and S&P recently downgraded Aralco to CCC and B- respectively, citing worries over short-term liquidity and subsequent refinancing risks, and

"They have engaged a local boutique to help them do the modeling," said one banker. "They are saying: my situation is much worse, so beware."

MUDDLING THROUGH

Fellow Brazilian name Virgolino de Oliveira (GVO) has also taken a beating, with its 2018s and 2022s making dramatic swings in the secondary over fears about its ability to cover payments.

S&P this week changed its outlook on GVO's B rating to negative, citing refinancing risks on its US$600m of outstanding bonds as well as the impact of interest expenses on its cash flow.

Still, holders of the 2018s were able to clip their coupon in January, and the assumption that GVO will also make good on the February 9 payment on its 2022s sent those bonds higher on Wednesday to 49.00-50.00.

The price differential between GVO and Aralco underscores how accounts are distinguishing between the two credits - and hoping that GVO can muddle through until production increases and prices rebound.

"The real challenge with GVO is the debt structure; they are too levered given their lower production levels," said a senior banker. "But they have made investments, so that should pay off in the next year."

A further easing of gasoline subsidies after the presidential elections in Brazil could also mean that more ethanol will be used at the pump, which also has the potential to benefit sugar companies.

"You are 12 months away from a better outlook on sugar and ethanol prices," said another banker. "The question is: can GVO survive over the next 12 months when balance sheets are stretched?"

BTG Pactual analysts said in a recent report: "While Aralco faces less refinancing needs than GVO, restructuring risks seem more meaningful as the company is in breach of covenants and has much lower equity value, limiting its financial flexibility options."

MAKING DISTINCTIONS

The slide in GVO and Aralco prices has had a knock-on effect on other sugar and ethanol names. However, there are signs that the buyside is starting to make distinctions.

For instance, Tonon's 9.25% of 2020s jumped several points Wednesday to hit 82.00-83.00 after trading at 78.00 Tuesday.

Brazil's Tonon is seen as the healthiest of the bunch. As opposed to the family ownership prevalent among most sugar companies in region, Tonon has professional management appointed by private equity fund Terra Via, which controls 35% of the company.

It has also incurred less debt than its peers, resorting instead to the sale of assets and a capital injection to raise funds for capex. Its net debt to Ebitda is around 3x as opposed to the 5 to 7x seen on names like Aralco, GVO and USJ.

The latter, which has 9.875% 2019s trading around 82.00, is also liked because of its large land ownership, which reduces leasing costs and can be used as collateral on debt as needed. It also has a joint venture with US multinational Cargill.

Both Tonon and USJ have seen their bond prices fall a good 20% since April last year, possibly creating some good buying opportunities.

A similar story is playing out in Peru, where sugar and ethanol company Coazucar's 6.375% 10-year (BB+/BB) has sunk to 76.50 on spillover concerns.

"A Double B credit shouldn't be trading like this," said one corporate trader. "You are talking 200bp over Cemex."

Bankers now wonder if US distressed and high-yield players will get involved in the Brazilian sugar sector, just as they did with fallen billionaire Eike Batista's shipbuilding unit OSX and the homebuilding sector in Mexico.

Some bankers already see value in GVO bonds, assuming a recovery value of 25 cents on the dollar.

"If you buy GVO at 50, you can lose 25, or you can make 50 if you get paid at par. So there is a 2-to-1 upside - and you are getting paid high-yield while you wait," one banker said.

But one senior banker said that is still some ways away.

"You need ownership by distressed players, but by and large I don't think they know the sector yet," he said. "They are doing their homework but they haven't started buying yet."

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