Raizen is a joint venture between Royal Dutch Shell PLC (AA/Stable/A-1+) and Cosan S.A. Industria e Comercio (BB/Stable/--), and we analyze it on a stand-alone basis. While we believe the shareholders’ strong knowledge of the markets Raizen operates in as very beneficial to the joint venture’s strategic decisions, we don’t incorporate notches of support to the ratings. The ratings reflect Raizen’s solid business fundamentals with economies of scale in its sizable sugarcane and fuel distribution businesses and our assessment of its moderate financial policies. We expect the company to keep leverage metrics in line with an intermediate financial risk profile, despite its aggressive expansion plan to expand its sugarcane crushing capacity to 80 million tons per year.
We expect the company to fund the expansion of its sugar and ethanol operations through internal cash generation, use cash position and long-term debt issuance. Raizen is planning to expand its sugarcane plantations, increase the cane productivity, improve operating efficiency of its industrial mills, integrate all its plants, and streamlining its logistics. We expect Raizen to increase expenditures in its fuel distribution segment by integrating its Esso gas stations and Shell’s gas stations in Brazil. However, we expect its annual maintenance capex to be low, of about R$200 million - R$300 million. The cash Raizen generates from fuel distribution and energy cogeneration-more than R$1.4 billion per year-enables it expand its more volatile agribusiness operations, which are exposed to global sugar prices, plantation productivity, unpredictable weather conditions, and trade barriers.
Intense rainfall in Brazil has postponed Raizen’s crushing activity in the past couple of months, which is reflected in more volatile quarterly cash flows. However, on an annual basis, we expect more rainfall to produce greater volumes of sugarcane. At the same time, we incorporate some, but not all, synergies from the integration of the sugar and ethanol operations with fuel distribution and somewhat conservative sugar prices, although part of 2012-2013 sugar sales has already been fixed at long-term forward contracts. Finally, we view Raizen’s expansion capex as highly discretionary, and we believe management is committed to maintain moderate levels of debt. We expect Raizen’s adjusted debt to EBITDA to be lower than 3.5x and adjusted operating margins in the 6.7%-7.5% range.
We view Raizen’s liquidity as adequate. Unrestricted cash at hand was about R$1.2 billion as of March 31, 2012, backed by a back-stop undrawn committed credit facility of $500 million (or about R$1 billion) and Shell’s planned capital injection of $540 million (or about R$1.1 billion). These sources of cash, combined with our estimate of annual funds from operations (FFO) of about R$3 billion, compare favorably with short-term maturities of about R$1 billion, capital expenditures of R$3 billion, and our expectation of dividend payments of about 50% of net income. We incorporate banks to start funding about half of the company’s capital expenditures in 2013, which we expect Raizen to receive at favorable terms.
We estimate Raizen’s sources of cash sources to exceed uses by more than 1.2x in the next few years, even if EBITDA declines by 15%. We believe Raizen has very good access to credit and capital markets, the funding from which the company could use to refinance working-capital and trade financing loans. Currently, Raizen has no covenants trigger in its debts.
The stable outlook reflects our view that Raizen will be able to maintain stable credit metrics despite its somewhat aggressive capital expenditures program. We believe cash flows will increase with the favorable demand for sugar and ethanol and its competitive position will strengthen due to its large-scale sugar production. Despite volatile cash flows from its sugar and ethanol unit, the robust cash generation from its fuel distribution and energy cogeneration businesses will keep credit metrics stable. Because part of the company’s capital expenditures is discretionary, it can rapidly adjust them if sugar/ethanol prices and demand drop.
A downgrade is possible if the company fails to adjust capital expenditures and/or dividend payout in a less favorable market environment, resulting in higher debt or depletion of its liquidity below what we consider adequate in our criteria. An adjusted debt to EBITDA consistently higher than 3.5x could lead to a downgrade as well. A positive rating action is not likely in the next two to three years, as the company will be going through an expansion plan and we don’t expect debt reduction in the near term. Indications of stronger support from Shell could have a positive influence on our ratings on Raizen.
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