Sao Paulo - If Brazilian sugar and ethanol companies thought 2009 was going to save them from a disastrous 2008, they might be in for a rude awakening.
Global sugar prices for 2009 are just barely covering the operational costs of most sugarcane mills. Ethanol continues to be the saving grace of the sector. After accruing tens of millions of dollars in debt in 2006 ethanol expansion, weak sugar prices and a lackluster exchange rate between the U.S. dollar and the Brazilian real have made it hard for companies to manage their debt burdens.
"Next year is still going to be a very tough year for sugar companies," said Vivian Zietemann, a corporate rating analyst at Standard & Poor's in Sao Paulo. One of the reasons is the world will still have abundant sugar stocks, and that is going to keep sugar prices relatively low. As it stands now, sugar futures have declined from closer to 16 cents for the March contract on the ICE Futures U.S. exchange to 14.35 cents for March on Wednesday's close.
That number is important because operational costs for many Brazilian mills is around 14 cents per pound, meaning prices for sugar have to be at that level for them to break even.
"Our operational costs are around 14 cents, and we are pretty sure that 2009 will be better for us to cover those costs," said Fernando Hayoshi, export director for Coruripe, a privately held mid-sized sugar and ethanol company.
Paulo Diniz, the chief financial officer of Cosan SA (CSAN3.BR, CZZ), said the company's operational costs were around 13.69 cents per pound. With March sugar expected to fall to 14 cents soon, as energy and soft commodities continue sliding, that doesn't leave much in the way of profit margins for Brazil's No. 1 sugar and ethanol company.
"Sugar has a clear disadvantage and I think that is going to continue. What we'd like to see is the real a little stronger," Diniz said on Aug. 26 during an investor conference. As long as ethanol is paying more for these companies, they will keep churning out more of it. So far, just 40% of the sugarcane crop has gone to making sugar, with the rest of it all going to make ethanol because of sugar's price disadvantages.
Diniz might get his wish when it comes to the foreign exchange, with the dollar rising to 1.71 Brazilian reals on Thursday, up almost 10% against the real in a month. Then again, the dollar was over BRL1.70 at the start of the year before it fell to BRL1.55 in July. At least for Cosan, the dollar has been going in the right direction even as sugar futures have weakened.
"What really helps Cosan is their cash position at this time," said Zietemann. "The company raised over a billion dollars in October 2007 and that has kept their debt manageable."
Cosan's credit is rated BB-, which is still below investment grade.
Not all of Brazil's sugar companies are in the same boat.
"If you break even in 2008, you did amazing work given a very tough situation in the commodities markets," said Antonio Duva, the soft commodities manager of BNP Paribas bank.
Sugar prices have been as volatile as crude oil prices, rising and falling just as fast. Also, with the ethanol component in sugar these days, sugar tends to also partially trade as an alternative energy commodity as well. The higher oil prices go, the more demand there is for cheaper ethanol and that increases the price of sugar. Companies that have some leeway, and not exclusively tied down to ethanol contracts with clients, can then make sugar instead. Normally, sugar and ethanol prices rise in tandem, but if sugar prices are too high, it makes producing ethanol too costly. These days, low sugar prices and high ethanol demand have been a Godsend.
Regarding 2009, Duva said that even though sugar prices are better right now for next year, operational costs will be higher.
"They'll still have debt to pay. They'll have increased costs like paying for land rentals. So sugar prices have to rise much more for margins to improve the way these companies would like to see them improve," Duva said.
Over the last several months, major publicly traded sugar and ethanol companies have had nothing but bad news in their earnings announcements, losing millions.
Cosan, which accounts for around 10% of Brazil's center-south sugarcane crushing output, lost 5.3 million Brazilian reals (3.4 million) in the fourth quarter compared to a net profit of BRL164.7 million in the fourth quarter of 2007.
Sao Martinho SA (SMTO3.BR) faired a little better, with a fourth-quarter net profit of BRL2.3 million, reversing a BRL619,000 loss in the fourth quarter of 2007. Most of that profit is thanks to ethanol or higher priced refined sugar.
"What saves a lot of these companies is product diversity," said Reginaldo Takara, a corporate rating analyst at Standard & Poor's.
"If you're just selling raw sugar or anhydrous ethanol, you're in trouble," Takara said.
Standard & Poor's had NovAmerica rated at BrBBB, a national credit rating for Brazil only tha