RIO DE JANEIRO--(BUSINESS WIRE)--Fitch Ratings has affirmed Vanguarda's foreign and local currency Issuer Default Ratings (IDRs) at 'B-'. Simultaneously, Fitch has downgraded its long-term National Scale Rating to 'BB-(bra)' from 'BB(bra)'. The Rating Outlook for all ratings is revised to Negative from Stable.
The downgrade of Vanguarda's National Scale Rating is based on the deterioration of its operational trends during 2010, which resulted from the lower yields and led to higher leverage, in excess of expectations. This rating action also considers the challenging funding structure which is more based on lines of credit than suppliers and advanced customer payments/deposits. Combined with these factors, the company continues to be exposed to refinancing risk, as the company has not able to issue the long-term debt as previously envisaged by Fitch. The Negative Outlook for both ratings stems from the challenges that Vanguarda faces to finance its operations going forward, while benefiting from the high commodity prices and better expected production. Leverage is expected to be in the 5.0 times (x) - 6.0x range by the end of 2011 and credit quality will likely be pressured should leverage remain above expected levels.
The 'B-' local and foreign currency IDRs are based on the company's exposure to fluctuation of commodity prices, volatile operational earnings, working capital requirements, high leverage and tight liquidity. Also considered are the corporate governance and risk management concerns. Balanced against these credit risks are the company's leading position in the production of soybean and cotton in Brazil, its vertical integration into animal proteins, and the land ownership by the group.
Leverage Metrics Are High:
As of September 2010, Vanguarda's leverage, as measured by total adjusted debt-to-EBITDAR, deteriorated to 8.4x from 2.9x in 2009. The company's EBITDAR dropped considerably to BRL52 million from BRL126 million in 2009 due to declining prices, appreciation of local currency (Real), lower production volumes sold and deterioration on the company's yields on it main crops' were the key drivers for the steep EBITDAR declines; while adjusted debt slightly increased to BRL443 million from BRL368 million, at the respective periods.
Fitch expects Vanguarda's EBITDAR to recover over the next several years, following the positive trends on commodity prices and the possible increase on operational profitability. However, the lack of supplier financing and advances from clients should result in a higher dependence on debt. Leverage is expected to recover to more conservative levels during the positive commodities prices environment but it should range at 5.0x - 6.0x. Additional debt to finance the expansion of its hog business should also pressure Vanguarda's leverage during 2012 to 2014, as the company carries out the investments.
In addition to evaluating traditional credit measures, Fitch's analysis of agricultural companies takes into consideration leverage ratios that exclude debt used to finance readily marketable inventories (RMI). Interest expense on debt used to finance RMI is reclassified to cost of goods sold from interest expense. With the adjustments described above, Vanguarda's total adjusted debt/EBITDAR was 7.6x for the latest 12 months (LTM) ended Sept. 30, 2010 and its EBITDA/interest expense ratio was 3.9x.
Weak Liquidity, Negative Free Cash Flow Generation:
Despite Vanguarda's weak liquidity, it survived the global liquidity crunch which resulted in the bankruptcy of several Brazilian agribusinesses by leveraging its good relationships with banks and suppliers as well as cutting investments in its intensive working capital cattle and trading business. The company's liquidity relies primarily on working capital loans from banks, as supplier financing and advances from customers became scarce over the last year. Although Vanguarda has been refinancing short-term debt with some medium-term credit lines with bankers, improving its debt maturity profile, refinancing risk is still a concern. As of Sept. 30, 2010, Vanguarda had BRL443 million in total debt, of which BRL196 million, or 44%, was short-term. This ratio improved from 66% short-term debt in 2009. However, cash on hand amounted to BRL9.5 million, covering only 5% of short-term debt.
Vanguarda's free cash flow (FCF) has been pressed by working capital and CAPEX needs. These requirements will be even higher in the future due to the expansion of the company's hog operations. As a result, Fitch expects free FCF generation to remain negative for the most part until the expansion of the hog operations reaches its goal of 715,000 heads per year (hpy) capacity during 2015. The company is seeking to finance its hog raising operations with funding through Brazil's development bank, BNDES. The first leg of these loans is expected to be granted in 2011.
Highly Productive Land and Soybean Production Leadership:
Vanguarda is one of the leading producers of soybeans and cotton in Brazil. The company, and the controlling family, own 66,000 hectares of land and manage 150,000 hectares of highly productive land, which are primarily located in the state of Mato Grosso. The controlling family is expected to transfer its remaining interests in the 66,000 hectares of land to the company, but currently these assets remain outside of the company.
Given the weather conditions, topography, and operating expertise of Vanguarda, the land managed by the company is amongst the most productive in the world, yielding about 2.9 tons of soybeans per hectare during the 2009/2010 crop. Vanguarda has also been able to harvest a secondary crop (cotton and corn) on approximately half of its land. However, company operations are exposed to weather condition and crop plagues, affecting its productivity.
For the LTM ended Sept. 30, 2010, Vanguarda's revenues totaled BRL490 million, of which 54% was generated by sales of non-genetically modified organisms (non-GMO) soybean sales. The state of Mato Grosso only allows non-GMO soybean production, which grants a pricing premium in the international markets. Cotton is its second main crop and represents about 40% of Vanguarda's sales.
Grain Diversification, Protein Vertical Integration Could Mitigate Cash Flow Volatility:
Soybean prices are volatile and output can be negatively affected by plagues and weather conditions. To mitigate some of the cash flow volatility associated with these conditions, the company has diversified into hogs. The production of a secondary crop also helps to offset the high working capital requirements of the planting season for soybeans, as does the leasing of land in the Brazilian state of Bahia, which has a different crop cycle than the farms in Mato Grosso. The company also plans to expand its hog operations from its current capacity of 150,000 hpy to 715,000 hpy in 2015. With this expansion, animal protein sales are expected to represent approximately 30% of the company's total revenues within the next five years up, from 9% during the LTM ended Sept. 30, 2010. Most of the feedstock for the company's pork business is grown internally.
Key Rating Drivers:
A rating downgrade could be triggered by a rise in the company's adjusted leverage, a restriction in cash flow generation even during the positive commodities price trends, an inability to continue rolling over short-term debt, a continuation of negative FCF generation.
Factors that could result in a positive rating action include the company's IPO, a sustained reduction in adjusted leverage ratio, reduction of the company's reliance on short-term debt, further revenue diversification, and/or the successful margin expansion from its vertical integration growth plans.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 13, 2010).
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646
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