The Brazilian Sugarcane Industry's Sweet Future
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Sugar is a sweet business in Brazil, and through Cosan Limited (NYSE: CZZ), investors now have their best opportunity to capitalize on one of the fastest growing companies in the fastest growing industries in one of the fastest growing economies in the world. Selling for less than five times enterprise value and earnings (both on TTM basis), and with several drivers towards meaningful future growth, why is Cosan one of the best international investments you can make in 2012?
Cosan is a vertically-integrated player in the Brazilian sugarcane industry, with operating arms covering nearly every facet of the world’s largest market for the crop. The corporation has already shown its huge growth potential over the past several operating periods: sugarcane crushing volume increasing 80% from 2006 to 2010, and its continued investment in capacity now allows it to handle up to nearly 30% more volume. Likewise, net revenues have increased at a near 58% CAGR between 2006 and 2010, and
The company’s huge growth potential and its operating efficiency steps from its unique vertically integrated foundation. Nearly 95% of revenues stream from two primary operating divisions, although two additional arms act to round off the corporation’s product/service portfolio.
- Raizen Energia
The sugar and ethanol production arm of Cosan generated around 17% of the corporation’s sales in the first half of its most recent fiscal year. This division houses 24 production mills with sugarcane crushing capacity of up to 65 million tons per crop year. Total volume crushed increased 14.2% over Q2 2011, and net revenues increased nearly 52% from comparable period last year.
The beauty behind this division’s operations is the ability for Cosan to take advantage of swings in both the raw sugar and ethanol markets. The corporation harvests and crushes raw crop internally and sources around half of its volume from other third party cane farmers, and because it has sugar and ethanol production capacity, Cosan is always in a position to optimize its sales mix. For example, with sugar prices increasing nearly 30% on the international market, Cosan geared and generated nearly 80% of this division’s revenues from the international trade market (up from 70% in the same quarter last year). Domestic ethanol sales also grew 84.4% in the most recent quarter to $570.5 million, taking advantage of both increased sales volume and favorable price increases.
- Raizen Combustiveis
Cosan’s ethanol distribution arm represented around 78% of sales in the first half of the most recent fiscal year. Through its recent joint venture with Royal Dutch Shell (NYSE: RDS-A), the corporation now markets fuel under the Shell brand name as well as its already established ESSO brand, which has been a well known Brazilian brand name for the past century.
The 2011 pairing of Cosan and Exxon Mobil (NYSE: XOM) also gives the corporation access to Mobil lubricant technology and the use of its brand name in marketing initiatives. Cosan relies on a large base of 1,700 filling station and 240 convenience stores located across 20 different Brazilian states for fuel distribution.
The Rumo Logistica and Cosan Alimentos divisions, although they represent a small portion of the corporation’s overall revenue, act to round out its product/service portfolio. Rumo provides logistics services in transportation, storage, and port elevation of sugar and other agricultural commodities for both Cosan and other third party operators, and Cosan Alimentos is responsible for the purchasing, packaging, and distribution of sugar for retail use in the domestic market (for consumer cooking, sweetening, etc.). Through the purchase of four other retail sugar brands, Cosan now controls more than 30% of the domestic market.
There are several key macro drivers behind the continued growth of Cosan’s operations.
- Expansion of Brazilian Market
Although the byproducts of corn (our #1 crop) can be broken down and distilled into ethanol fuel, the market has not yet gained significant traction in the United States. Two of the primary reasons behind the market remaining at an immature stage are the long-lived food vs. fuel controversy, and limited participation from private investors.
The Brazilian ethanol fuel market is almost a mirror image due to significant government interaction over the past half century. Since 1976 the government set mandatory mix levels with gasoline, which have historically been between 20% - 25% ethanol, so consumers have always been exposed to the alternate fuel source.
Due to the recent shortfall of ethanol fuel in the country – weather conditions and poor reinvestment in the crop after the recent economic downturn led to relatively little volume growth over the past few years – the market has been struggling to feed the raging domestic demand. Although demand currently outstrips supply by nearly 25%, the long term forecast for the industry is extremely positive, and producers like Cosan should continue to experience significant levels of organic growth going forward.
First, the capacity to service the growing demand will improve. Brazil currently has more spare farmland than any other country in the world, and actually has more additional capacity than the next two countries, United States and Russia combined (Source: FAO). As the nation continues its rapid internal development and its infrastructure expands, the ability to access additional land and boost cane production can only improve.
Long term demand for the product should not be an issue either, even after the supply/demand imbalance is corrected. Three of the world’s leading car manufacturers, General Motors (NYSE: GM), Volkswagen, and Fiat are all investing heavily in the market that is expected to grow at a consistent 5% per year over the next several years. GM is on track to complete its recent $3 billion investment in the country by the end of 2012, and in adding a third shift at its Sao Paulo-based plant, the automaker will have capacity to pump out 250,000 vehicles per year. VW and Fiat, Brazil’s most popular automaker, are spending $3.3 billion through 2016 and $6 billion through 2014, respectively, to each be on track to sell more than one million vehicles annually (Source: IHS Automotive). With median incomes increasing, with and with 95% of auto sales going towards “flex fuel” vehicles (runs on fuel, ethanol, or combo), the long term industry prospects are the strongest in the world.
- Favorable Long Term Prices
Due to the aforementioned poor harvests over the past several years, the significant supply/demand dynamics have led to very favorable price increases for Cosan. With both sugar and ethanol production capacity, the corporation’s operations are established to create a natural hedge against fluctuating sugar prices. When sugar prices are on the rise (as they have been), Cosan has the option to gear its operations towards the international export market. Raizen Energia’s sugar export revenue increased over 50% in the most recent quarter despite only a minimal volume increase (consumers will tend to purchase less as the commodity increases in price). Likewise, the ethanol production operations can be heavily favored when and if sugar prices tend to revert back to a mean in time – there sure will not be any shortfall in demand.
- International Growth
Even without the domestic shortfall of ethanol fuel in Brazil, and even with the end of the 30 year tariff the U.S. government established to protect American farmers from a flood of Brazilian fuel imports, there is still limited means for the country to supply the world with ethanol fuel on a large-scale basis. Infrastructure in the way of pipelines, port facilities, and storage capacity is in immature stages. However, a coalition of Brazilian fuel producers have invested in a 1,300+ km pipeline, expected to be completed by 2015, which will reduce fuel transportation costs by up to 40%.
Likewise, foreign oil investors are placing a heavy bet on the viability on the alternate fuel source. Shell and Cosan’s recent multi-billion dollar joint venture highlights the point – the world’s largest fuel producers are willing to direct a meaningful portion of their resources and future growth initiatives on the Brazilian market in order to have the ability to sell the cleaner fuel on a worldwide basis.
At such modest market valuations, and with huge growth prospects going forward in both the sugar and ethanol markets, there is no doubt that prospective investors will enjoy sweet success with Cosan!
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