Friday, April 18, 2014

Crushin' in Brazil

In the last post we looked at Cosan Ltd. (CZZ:  NYSE), Brazil’s leading sugar cane grower and processor as well as ethanol producer.  The article came about because last week I had the opportunity to attend the 2014 Cross Border M&A Symposium in New York City which featured the so-called BRICs and other cross-border opportunities.  Brazil figured prominently in the discussion.  I thought it a good idea to check up on Brazil’s participation in the alternative energy industry.  Of course, the first thing we think about Brazil in the context of alternative energy is sugar cane and ethanol.

Prices for sugar have dropped dramatically over the past three years, and for most producers are lower than production costs.  Consequently, most Brazilian sugar producers are focused on biofuel.   Ethanol production increased 19% in Brazil in 2014, while sugar production rose by less than 1%. 

The three largest processors in Brazil include Cosan Ltd, Sao Martinho and Acucar Guarani.  In this post we will look at Sao Martinho, which trades on the Sao Paolo exchange under the symbol SMTO3F.   

Sao Martinho is a sugar cane grower and producer. The company reported crushing 15.6 million tons in the 2013-14 growing season, approximately 25% of which comes from third parties.  This represented 21% growth over the previous year, which management attributed to higher yields in its own sugar cane fields as well as expansion of its growing area.  Sao Martinho output supports a bit more than 2% of Brazil’s ethanol production and approximately 3% of sugar production. 

The company has also reported improving profit margins, which have come about largely from economies of scale as volumes increased.  Increased ethanol prices have also been a plus for Sao Martinho’s bottom line and ethanol sales is an increase portion of total revenue. 

The company has been a strong generator of operating cash flow.  The cash has been vital in enabling growth through acquisition.  The most recent deal was the purchase of additional non-controlling interest in Santa Cruz, a sugar cane mill.  Sao Martinho will be using cash on hand to make payments over the next three years.   The deal brings Sao Martinho’s interest in Santa Cruz to 36%.

Shares of Sao Martinho trade at 25.1 times trailing earnings, but offer a 20% step-up based on the consensus estimate.  Trading volume is modest in the stock with only about 0.2% of the outstanding shares change hands in a day.  The stock offers a dividend yield of 0.9%, which provides a nice bump for investors who take a position in the stock for the sake of long-term growth.      

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.


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