Fitch Publishes Jalles Machado's IDRs of 'BB-'/'A+(bra)'; Outlook Stable

Fitch Ratings has published Jalles Machado S.A.'s (Jalles Machado) 'BB-' foreign and local currency Issuer Default Ratings (IDRs) and 'A+(bra)' long-term national scale rating. The Rating Outlook for the corporate ratings is Stable.

KEY RATING DRIVERS

Jalles Machado's ratings reflect the company's strong business model and robust operating margins. Jalles Machado has a premium portfolio of products that includes branded organic and crystal sugar, as well as energy production from its cogeneration power plants. The company benefits from fiscal incentives on the sale of sugar and ethanol and relatively low land lease costs. The ratings incorporates the company's strong agricultural performance due to its adequate investments in the cane fields, the use of irrigation over a relevant portion of its harvest area and self-sufficiency in sugar cane, which explain the lower volatility of Jalles Machado's operating cash flow generation compared to most of its peers.

Fitch expects Jalles Machado's leverage to remain at moderate levels for the sector and that the company will improve the weak liquidity position posted at the end of fiscal year 2014. The agency also considered that Jalles Machado's free cash flow (FCF) for fiscal year 2015 should benefit from higher utilization of its two mills and the just finished investments in expansion of planted area. The ratings incorporate the company's exposure to the inherent volatility of sugar prices, currently at low levels, and the Brazilian ethanol industry dynamics, which is strongly linked to Brazil's regulated gasoline prices and related government energy policies. Jalles Machado's business risk also includes the exposure of its sugarcane production to weather conditions.

Robust Business Model

Jalles Machado's business profile benefits from its own sugar cane that accounts for 100% of its total origination needs and artificial irrigation coverage of around 60% of the company's harvest area. Jalles Machado is a family-owned sugar and ethanol producer that runs two mills - Jalles Machado and Usina Otavio Lage - in the State of Goias with crushing capacity of 4.3 million tons of sugarcane. The company also runs two co-generation assets with total installed capacity of 88 MW and sells the energy surplus to the national grid. The sale of energy from cogeneration also contributes to Jalles Machado's robust operating margins and helps to reduce the impact of the inherent sugar and ethanol price volatilities on the company's operating cash flow generation.

EBITDAR Margins Above Industry Peers

Jalles Machado offers a differentiated product portfolio that contributes to EBITDAR margins within a range of 66% and 75%, which compare favorably with the industry average. In fiscal year 2014, ended on March 31, 2014, net revenues increased by 14% to BRL443 million and EBITDAR amounted to BRL333 million, at a 75% margin. The company's premium portfolio of products includes the sale of branded organic and crystal sugar, the latter holding relevant market share in Brazil's Northern and Northeastern retail markets. Prices for both products command large premiums compared to VHP sugar. Product mix also includes sale of hydrous, anhydrous and industrial ethanol. In fiscal year 2014, Jalles Machado's net revenues were broken down as follows: hydrous ethanol (29%), crystal sugar (24%), anhydrous ethanol (17%), organic sugar (15%), energy (7%), raw sugar (6%) and others with the balance.

High operating margins also reflect the company's fiscal incentives provided by the State of Goias on the sale of sugar and ethanol. In fiscal year 2014, tax incentives alone added BRL32 million to Jalles Machado's EBITDA. The company's low land lease costs, well below the average of the State of Sao Paulo, also play a role. The self-sufficiency in sugar cane has a positive accounting impact on Jalles Machado's margins. As spending on the cane fields is accounted for as capital expenditure rather than cost, the higher the share of own cane in the mix, the larger the capital expenditure and the lower the cash cost.

Positive FCF Expected for Fiscal Year 2015

Jalles Marchado's cash flow from operations (CFFO) should benefit in fiscal year 2015 from full utilization of the company's mills and recent investments in the expansion of its harvest area. The company crushed 1.6 million tons of sugar cane in the first quarter of 2015 (1Q'15), up 30% from 1Q'14. In the 1Q'15, agricultural yields are up by 24% and 16% at Jalles Machado and Otavio Lage mills, respectively, on a year-over-year comparison. It is expected the company's two units to operate near 100% of maximum capacity and its cane fields to generate excess sugar cane production of 380,000 tons in fiscal year 2015. The company has just come out from an investment program that increased its harvest area to 44,000 hectares at the end of fiscal year 2014 from 29,000 hectares in fiscal year 2010.

Jalles Machado's FCF should turn positive in fiscal year 2015 and remain in surplus in the years that follow, assuming average sugar and ethanol prices in line with the average of the last 12 months and foreign exchange rate at current levels (USD1/BRL2.30). This scenario also considers that Petroleo Brasileiro S.A. (Petrobras) will keep imposing an indirect cap on hydrous ethanol prices by exercising a tight control on gasoline prices. In fiscal year 2014, Jalles Machado posted negative FCF of BRL36 million, down from negative BRL85 million at the previous year. In the latest 12 months (LTM) ended on March 31, 2014, Jalles Machado reported robust CFFO of BRL206 million, which compares favorably to BRL169 million in fiscal year 2013. In this analysis, Fitch assumes that Jalles Machado will postpone any investment in expansion of planted area and increase of crushing capacity as long as sugar and ethanol prices remain at current levels.

Moderate Leverage to Remain

Fitch expects that Jalles Machado will be able to keep leverage at the currently moderate levels. In fiscal year 2014, the company's total adjusted debt-to-EBITDAR ratio was 3.4 times (x), while net adjusted debt-to-EBITDAR ratio was 3.0x, well below the average of the sector. These ratios compare favorably to 3.5x and 3.0x, respectively, in the previous year. As of March 31, 2014, the company's total adjusted debt by installed capacity was BRL266 per ton, above the average of companies covered by Fitch and greatly explained by the recent conclusion of investments in planted area.

As of March 31, 2014, consolidated adjusted debt including obligations related to land lease was BRL1.1 billion, of which USD-denominated debt accounted for 30%. Principal and interest payments up to September 2015 are protected through derivatives. Jalles Machado's debt consisted of working capital (32%); trade finance facilities (30%), land lease agreements according to Fitch's methodology (18%); financings from the Brazilian Economic Social and Development Bank (BNDES, 15%); and others (5%).

Weak Liquidity

Jalles Machado's liquidity has been historically weak. The company's main challenge is to pursue a healthier debt maturity profile and stronger liquidity with aims at reducing refinancing risks as well the impact of the inherent sugar and ethanol price volatilities on its operating cash flow generation. As of March 31, 2014, the company's cash reserves of BRL132 million covered only 54% of its short-term debt obligations down from 73% as of March 31, 2013. Jalles Machado's short-term debt coverage stood at 1.42x and 1.37x as of fiscal-year 2014 when funds from operations (FFO) and CFFO were added to the cash position, respectively. The company has raised additional long-term finance of BRL65 million (tenors of up to seven years) since the closing of fiscal year 2014 and Fitch will keep monitoring if the company's expected liquidity improvement is sustainable over the long run.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action:

--Deterioration in Jalles Machado's financial profile, with adjusted net leverage going above 3.5x;

--A short-term debt coverage ratio, measured by (CFFO + cash and marketable securities)/short-term debt below 1.2x on a consistent basis.

Future developments that may, individually or collectively, lead to a positive rating action:

--Strengthening of Jalles Machado's financial profile, with adjusted net leverage equal or below 2.0x;

--A short-term debt coverage ratio, measured by (CFFO + cash and marketable securities)/short-term debt equal or higher than 2.5x.

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=875934

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