CONSUFOR at O PAPEL Magazine
In this issue of O Papel, Marcio Funchal and Adriane Roglin at business consultancy CONSUFOR provide an analysis of financial data on Brazil’s four biggest pulp and paper companies regarding their annual leveraging level between 2015 and 2017. The numbers presented in this article do not contemplate the merger between Suzano and Fibria, that is, data for both companies was analyzed individually.
The analysis showed that leveraging levels are high, creating business opportunities for forest asset investment funds. Financial leveraging is an index that translates the share of third-party capital in the capital structure of a company. That is, using third-party resources at competitive rates, with the objective of obtaining substantial gains without increasing spend in the same proportion.
Indebtedness can be understood as something good when used in accordance with the capital structure of a company. Higher levels of indebtedness translate in higher financial costs, therefore, companies have been seeking alternatives to sell certain less-strategic assets in order to reduce debt and have cash. Gross debt figures for the four biggest Brazilian companies in the pulp and paper segment (Klabin, Fibria, Suzano and Eldorado) show that the gross indebtedness level increased roughly 8 percent in the last three years (Figure 1).
Individually, only companies that did not make recent expansions maintained their figures with minor changes. The increase in this indicator (from R$ 55 million to R$ 59 million) was the result of recent expansions made by companies, such as: Project Puma carried out by Klabin in Ortigueira/PR and Horizonte 2 executed by Fibria at its Três Lagoas/MS industrial unit. However, factors like long-term debt and competitive costs improved the debt profile of companies. In the last two years, total net debt (Gross debt – cash available) dropped and gross debt (sum of loans, financing and debentures) increased, going from a ratio of 80% in 2015 to less than 70% in 2017, (Figure 2).
The factors that contributed the most to this movement were the need of companies to increase cash generation and reduce working capital. Money available that’s not doing anything does not create return for shareholders, likewise, little money on hand increases liquidity risk. However, each company possesses a financial-cycle strategy that allows meeting short-term obligations.
The individual level of leveraging of companies evaluated varied between 6.3x and 2.1x in the three periods analyzed. As such, if there are no changes in costs and revenues over the next years, one of the companies would take 6.3 years at the most to pay its debts and a minimum of 2.1 years, not taking taxes into consideration. In the latest financial statement of these companies (fiscal 2017), following conclusion of the Klabin and Fibria expansions, figures are more balanced, varying between 4.1x and 2.1x, averaging 3.0x (Figure 3), compared to the almost 4.0x in previous years.
Factors such as production-cost reductions and currency-exchange increases that directly affect pulp prices, have become important indicators that favor a better adjusted EBITDA. The constant goal of reducing production costs is a reflex of the increase in the use of raw material from own forests and operational efficiency gains (productive process). Additionally, the recent Fibria and Suzano merger will allow for a reduction in average supply distance in some industrial units, like Fibria’s Aracruz unit, which will be able to count on Suzano’s forests to supply the mill.
Klabin still presented high leveraging levels of around 4.1x in 2017. Compared to Fibria (recent expansion), Klabin has been deleveraging at a slower rate, and the main factors that contributed to this result are changes in market conditions regarding pulp prices and foreign exchange. Additionally, internal and external contracts, strategic company decisions, dilution of operating costs, debt terms, among others, affected the company in varying proportions.
On the other hand, Suzano, which until 2017 presented few investments, has the lowest index (2.1x). In 2018, with the Fibria acquisition, Suzano completely altered the company’s decision route, as it was significantly reducing its leveraging since its last major expansion, in 2013, at its industrial unit in Maranhão. In its latest acquisition, since a major part of the value was financed through debt, a part of it in securities, the level of leveraging will reach higher levels, quite possibly close to the indebtedness level defined by the company (3.5x). Nevertheless, the acquisition should generate economies of scale and higher profit margins than current ones, which could lead to a rapid recovery in indebtedness level in a much shorter time frame.
Fibria exceeded its maximum level of leveraging in the first quarter of 2017, when it reached 3.8x with Project Horizonte 2 (expansion of the Mato Grosso do Sul unit). However, even before it began operating the new pulp production line, the company already began its deleveraging process, ending 2017 at 2.5x. In turn, Eldorado has been reducing its indebtedness level annually. It reached its peak in 2016 (5x), but during 2017, it reduced it to 3.4x, thanks to improvements in the company’s operating performance and market conditions in the pulp sector. One of the main factors that contributed to this result was cash generation, which once amounted to 40 percent more than in 2016.
Despite the financial health of these companies, the indebtedness level is also an indicator of risks and, therefore, has implications in the cost of third-party capital, thus reducing shareholder return. Therefore, in a mature forest market, it would be financially healthy to sell a part of current biological assets in order to reduce these financial indicators. Obviously, what fraction of assets could be sold to investors is a strategic decision of each company. As such, in a hypothetical scenario of selling all biological assets of companies, which amounted to around 15.4 million in 2017, the four companies would reduce, on average, only 38% of their net debts (Figure 4).
In the hypothetical analysis of reducing the net debt of companies with funds from the sale of biological assets, the new leveraging scenario of companies (Figure 5) would vary between a comfortable level (<2.0x) and an acceptable level (>2.0x and <3.5x), thus ensuring access to credit lines that would maintain the low weighted average cost of capital (WACC). It’s important to point out that, in addition to selling a portion of existing assets, new expansions in forest bases should also be done, in part, through partnerships with domestic and international investors. An excellent long-term opportunity with attractive returns, especially because investors could be responsible for part of the future supply to these companies.
In a scenario considering domestic and international investors, several business models could be adopted, where timeframes, cycles, prices and guaranteed returns could be contemplated in negotiations, in order to maximize investor returns and minimize supply risks in the industry. The sale of land should also be considered, further increasing the current capitalization of companies and generating opportunities for real estate investment funds, which business volume in the country is quite low. Therefore, it’s important to conduct a detailed analysis of seller/ consumer needs, as well as the particularities of investors. Also, follow the design of a detailed business plan that’s adequate and adapted to market conditions and will base future contracts, ensuring robustness to the business and maximizing return on projects.
This article was originally published in the Revista O Papel magazine, specialized in the pulp and paper sector(August/2018).
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