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Fitch Affirms Tereos at 'BB'; Outlook Stable
June 7, 2017 / 4:00 PM / a month ago

Fitch Affirms Tereos at 'BB'; Outlook Stable

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(The following statement was released by the rating agency) MILAN/PARIS/LONDON, June 07 (Fitch) Fitch Ratings has affirmed Tereos Union de Cooperatives a Capital Variable's (Tereos) Long-Term Issuer Default Rating (IDR) at 'BB' with a Stable Outlook. The senior unsecured ratings of the bonds issued by its subsidiary Tereos Finance Groupe 1 were also affirmed at 'BB'. The rating affirmation reflects Tereos's strong business profile, which remains offset by a volatile financial profile. We expect the company's credit metrics to improve in the financial year ended 31 March 2017 (FY17), particularly leverage and funds from operations (FFO) fixed-charge cover, after three years of weakening as sugar prices dropped. However, the new EU sugar regime from September 2017, combined with the inherent volatility of sugar prices, makes the sustainability of this improvement trend uncertain at this stage. The company enjoys a strong market position, supported by well-invested assets, access to the produce of member-farmers operating in some of the higher-yielding sugar beet regions in Europe and growing diversification of geography and raw materials. The cooperative ownership profile of Tereos also contributes to its conservative financial policies as reflected in the rating. KEY RATING DRIVERS Strong Business Profile: The IDR is underpinned by Tereos's strong business profile for the 'BB' category, both in operational scope and position in commodity markets with potential for long-term growth. Geographic and product diversification, with an important portion of sales and profits being generated outside the company's historic French sugar beet operations, as well as efforts to increase operating efficiency, also support Tereos's business risk profile. Profit Rebound: Tereos strongly boosted revenue and profit in the nine months ending December 2016 (9M17) thanks to a combination of sugar and ethanol price recovery and benefits from cost efficiency programmes. We expect FY17 results to confirm the trend, and profits to further grow in FY18 albeit more moderately. Any drop in European sugar prices is likely to be more-than-compensated from higher sugar beet volumes and greater efficiency. We also expect the starch and sweeteners business to contribute more to profit, due to an improved product mix, larger capacity and better efficiency. We therefore consider the FY16 results as the company's lowest EBITDA point in the current cycle. Exposure to European Sugar Price Adjustment: European prices recovered in FY17 due to lower production, which led to a rapid drop in stock-to-use ratios. However, they are likely to decrease again as they converge with lower international prices, along with the removal of the quota regime in September 2017. Similar to other European sugar processors, Tereos's European sugar beet business suffered a sharp contraction in profitability in the last few years. Its EBITDA dropped in FY16 to EUR146 million (less than a third of its FY13 level), following a steep decline in EU quota sugar prices largely linked to the intervention of the European Commission in 2013. Higher European Sugar Volume Upside: We expect the group to benefit from a post-2017 deregulated European sweeteners market due to strong market share and competitiveness. The EU sugar reform will lift constraints on production and exports from Europe. Tereos has contracted with member-farmers in France to increase production of sugar beet so that increased volumes can more than compensate for lower selling prices. We therefore project that EBITDA from Tereos's European sugar beet operations will keep growing in FY18. Improvement of Credit Metrics: We project RMI-adjusted funds from operations (FFO) gross leverage should return below 4.5x in FY17 after having peaked at 6.1x in FY16. Similarly, we expect RMI-adjusted FFO fixed-charge cover to have reached its low point (3.0x) in FY16 and to recover to around 3.5x from FY17. Such improvement in financial metrics should be supported by higher FFO and RMI value. These levels are comfortable for the ratings. We expect free cash flow to remain mildly negative over FY17-FY18 due to working capital absorption in FY17 and FY18. In addition, we project capex to remain high at an average EUR400 million annually. Adequate Financial Flexibility: Tereos's weak credit metrics are partially mitigated by adequate financial flexibility. The latter is supported by strict financial discipline in shareholder distributions and M&A spending, adequate liquidity management and healthy RMI-adjusted FFO fixed-charge cover throughout the commodity down-cycle. In the low sugar price environment, cooperative owners have shown their support to Tereos by accepting a sharp reduction in "price complements", which we consider akin to dividend distributions. While there has been a modest increase in distributions in FY17, we assume these will remain low so long as the profitability of Tereos's European sugar business remains low. Parent-Subsidiary Linkage: Tereos France's (TF) and Tereos's influential control as well as their legal and strategic ties with TI are very strong. These compensate for limited, albeit growing, operational, financial integration and ownership - and make parent and its subsidiary intrinsically linked. We also expect a degree of convergence in the financial profiles of both TI and its French holding. Average Recovery Prospects: Due to the strong linkages between TSF, Tereos and TI, the rating on the senior unsecured notes is derived from the consolidated group's IDR of 'BB'. The senior unsecured notes are rated at the same level as the group's IDR. Usually, for issuers rated in the 'BB' category, prior-ranking debt constituting 2x-2.5x EBITDA indicates a high likelihood of subordination and lower recoveries for unsecured debt. We believe that the level of senior secured (or other form of prior-ranking) debt leverage at TSF is unlikely to rise higher than 2.0x over the next three years as we expect a recovery in EBITDA from the sugar beet business. Furthermore, we believe TSF (or Tereos) is unlikely to increase its debt to support other group entities. Revolving Credit: In addition, existing committed debt ranking ahead of the senior unsecured notes relates to TSF's EUR450 million revolving credit facility (RCF), which exclusively funds working capital needs throughout the year. Based on the company's historical intra-year working capital needs, average intra-year outstanding RCF amounts are unlikely to rise beyond 2.0x TSF's EBITDA. DERIVATION SUMMARY Tereos's IDR of 'BB' is positioned in between the credit quality of larger and significantly more diversified commodity trader and processor Bunge Limited (BBB/Stable) and the 'B' category rated Kernel Holding S.A. (B+/Stable) and Biosev S.A. (B+/Negative), whose ratings discount a heavy concentration on one country where they originate the commodities they process and sell. Tereos enjoys a moderate degree of geographic diversification with material sourced mainly in western Europe and Brazil but also in The Indian Ocean and Asia as well as combining production of beet sugar, cane sugar, sweeteners, ethanol and starches. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue to grow in FY17 at a pace (low teens) aligned with 9M17 performance; further strong growth (mid-to-high single digit) in FY18, resulting from higher volumes more than compensating the lower prices that will result from the EU sugar reform from the second half of FY18 and adverse FX effects in Brazil; broadly stable revenues from FY19; - Consolidated EBITDA margin recovering to around 12.5% in FY17 (10% in FY16; 14.8% in FY14) and 13% in FY18 as a result of better prices, product mix and/or benefits from efficiency programme; constant at 13.0% over FY18-FY20; - Working capital absorption over FY17 and FY18 as a result of price (FY17) and volume growth (FY18); - Capex remains around EUR400 million annually on average until FY19 as company continues to invest in higher efficiency and increases capacity; - Buyout of Petrobras's stake in Guarani and of Tereos Internacional minorities for close to EUR210 million in FY17; EUR40 million per annum bolt-on M&A thereafter RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Strengthening of profitability (excluding price fluctuations), as measured by RMI-adjusted EBITDAR/gross profit, reflecting reasonable capacity utilisation rates in the sugar beet business and overall increased efficiency. -At least neutral FCF while maintaining strict financial discipline. -FFO gross leverage (RMI-adjusted) consistently below 3.5x at Tereos group level. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Inability to sustainably maintain cost savings derived from efficiency programmes or excessive idle capacity in different market segments, leading to RMI-adjusted EBITDAR/gross profit remaining weak. -Inability to return consolidated FFO to approximately USD500 million (FY16: USD300 million and to improve profitability and cash flow generation. -Reduced financial flexibility as reflected in FFO fixed-charge cover (RMI-adjusted) falling below 3.0x. - FFO gross leverage (RMI-adjusted) above 4.5x at Tereos group level on a sustained level. LIQUIDITY Adequate liquidity: Tereos's internal liquidity score, defined as unrestricted cash plus RMI plus accounts receivables divided by total current liabilities, improved to 1.1x in FY16 from 0.7x in FY14 as management successfully lengthened the group's average debt maturity profile. This is consistent with levels for a 'BB' rating. Liquidity is further supported by comfortable access to diversified sources of external funding, demonstrated by the successful issue of seven-year bonds in June and October 2016 and the full refinancing of its sweeteners business in Europe in December 2016 with a EUR200 million revolving credit facility. Contact: Principal Analyst Anne Porte Director +33 1 4429 9136 Supervisory Analyst Giulio Lombardi Senior Director +39 02 8790 87214 Fitch Italia S.P.A Via Morigi 6 20123 Milan Committee Chairperson Raymond Hill Senior Director +44 20 3530 1079 Media Relations: Francoise Alos, Paris, Tel: +33 1 44 29 91 22, Email: francoise.alos@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Summary of Financial Statement Adjustments - Leases: Fitch adjusted the debt by adding a multiple of 6x of yearly operating lease expense related to long-term assets (EUR38 million for FY16). The multiple of 6x reflects operating lease expenses related to the group's Brazilian operations. - Readily marketable inventories (RMI): Fitch calculates Tereos's financial ratios by excluding the debt and the interest costs used to finance those RMIs for which the agency has reasonable assurance from management that they are protected against price risk. In FY16 Fitch judged EUR334 million of Tereos's inventories as readily marketable, based on EUR595 million of inventories of finished products. Therefore Fitch adjusted the group's debt and gross cash interest down by EUR334 million and EUR29 million, respectively. - Factoring: Fitch views the group's factoring programme as an alternative to secured debt, and therefore adjusts Tereos's FY16 total debt by the amount of receivables sold and derecognised at end-FY16 (EUR128 million). Fitch has also decreased the group's working capital inflow (included in Fitch's FCF calculation) by the year-on-year increase in outstanding factoring funding at closing, i.e. EUR31.5 million. Cash flow from financing (excluded from Fitch's FCF calculation) has been increased by the same amount. Additional information is available on www.fitchratings.com. 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