NEW YORK & SAO PAULO--The upward trend in sugar prices should improve cash flow generation for the Brazilian Sugar and Ethanol (S&E) industry over the medium term, but the ability of most companies to quickly recover a stronger credit profile will be limited, according to Fitch Ratings.
Supply and demand fundamentals suggest that the upward price trend could be long term, although the recent spike in prices has been fueled by excessive and unusual rains in Brazil's Center-South, the country's largest producing region, it is also attributable to a strong appetite from investment funds.
The 2015-2016 global season is expected to see the first shortfall in output relative to demand compared with the past four seasons. Global sugar stocks ended May 2016 at their lowest level since 2011, pushing down the stocks-to-use ratio. The steady 2% annual increase in global demand, combined with significant reductions in India's and Thailand's sugar output due to El Nino and the lack of crushing capacity expansion in Brazil, could also be supporting factors for keeping international sugar prices on their current upward trend.
The benefit of the recent price surge is not immediate as most Brazilian S&E companies with access to the derivative markets and/or credit limits at trading companies had already hedged their sugar positions before the beginning of the Brazilian ongoing crop season to end on March 31, 2017. The unfavorable sugar and ethanol prices seen in past years have led several companies to file for bankruptcy protection, which also makes the recovery scenario more challenging.
International sugar prices have been rising robustly, ranging from USD15 cents/pound-USD20 cents/pound since April 2016, 13% higher than the average during the same period last year. Nevertheless, the timing at which Brazilian S&E companies hedge their sugar positions vary according to each company's commercial and hedging strategy; Brazil's largest players have 50%-70% of their expected sugar exposure hedged before the beginning of the ongoing crop season. In BRL terms, international sugar prices are currently trading at a quite attractive BRL1,400/ton (USD19 cents/pound) and companies with the most efficient hedging policies entered the season with hedged sugar positions averaging BRL1,200/ton (USD14 cents/pound).
Companies like Raizen Energia S.A and Jalles Machado S.A favor sugar production and are expected to channel extra revenues to pay down debt and initiate a deleveraging process. Despite the challenging scenario in 2014 and 2015, they have not ignored investing in fields and mills. The benefit for financially distressed S&E companies will be limited as they continue to favor ethanol production over sugar due to the much shorter cash conversion cycle involved in fuel production. These companies will have a restricted ability to deleverage as they may not have the resources to pay down debt and resume investments in the field and industrial assets.
Prices of hydrous ethanol have not kept pace with the spike in sugar prices as the beginning of the current harvest season has pushed hydrous ethanol prices down by 12% since April 2016. The indirect cap imposed by gasoline prices is also a limiting factor in achieving a more sustainable increase in ethanol prices.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.