Cosan undervalued on strong underlying execution – cosan limited (nyse czz) seeking alpha 9gag instagram videos


Cosan ( CZZ) isn’t, and never will be, the easiest stock to own. In addition to a complicated ownership structure, the company is heavily exposed to commodity market prices that it cannot really influence and the volatility of the Brazilian real. Even so, I believe Cosan management continues to do a good job of managing the business and controlling what it can; the company’s sugar/ethanol and fuel operations are run quite efficiently, and management has already shepherded a meaningful improvement in the Rumo rail operations. In addition, management has signaled that at the holding company level (the CZZ shares), they are ready and willing to start returning more cash to shareholders, preferably through buybacks. Strong Results, But It’s Going To Get Tougher

Cosan SA saw 17% revenue growth, driven by 10% growth at Raizen Combustiveis (the Raizen businesses are split 50/50 with Royal Dutch Shell ( RDS.A)( RDS.B)) and 55% growth at Raizen Energia. There was nothing particularly magical about the Combustiveis performance; steady execution, with ongoing volume (up 3%) and market share growth in diesel and gasoline/ethanol.

With Energia, the company saw a significant benefit in holding inventory from the fourth quarter and selling at higher prices in the first quarter; while the underlying production mix was 55% sugar/45% ethanol, the sales mix was 18%/82% because of that inventory carryover.

Adjusted EBITDA, though better than expected, couldn’t keep pace with revenue, and the 11% growth reflected a half-point decrease in margin. Energia saw the worst margin erosion at around 10 points (down to 22%) on weaker ethanol and sugar prices, but every business saw year-over-year erosion, albeit less than expected, and Combustiveis’s EBITA per cubic meter was up 4%.

Cosan’s Rumo rail operations were also stronger than expected in the first quarter. Revenue rose at a high teens rate, supported by 18% volume growth (North Operations were up 17%, South up 19%). EBITDA grew 32% and margin expanded more than five points, but the business continues to consume cash as the company reinvests in infrastructure. Sugar Going Sour

As I wrote about a month ago in reference to Adecoagro (NYSE: AGRO), Brazil’s sugar producers are in for a tough year (or two… or three) as production growth in the EU and India lead to significantly higher global inventories and weaker prices. Recent spot prices were around $0.12/lb, a level where Adecoagro’s uncommonly efficient operations can still make a profit, but where Cosan SA is likely looking at negative incremental margins.

With that, Cosan SA will be looking to shift more volume toward ethanol production at the cost of sugar production. That is fine as far as it goes; Cosan SA does have the capacity/capability to increase its ethanol mix and higher oil prices will keep the price of imported fuels high in Brazil, but there’s only just so far Cosan SA can shift its mix and it hasn’t hedged much of its expected sugar volumes (less than 20%). Moving Into Argentina… Good Value, Or “Cheap For A Reason”?

Around a month ago, Cosan/Cosan SA announced that Raizen Combustiveis was going to acquire Royal Dutch Shell’s downstream assets in Argentina for less than $1 billion. These operations include a refinery (responsible for about 17% of Argentina’s capacity) and close to 650 gas stations with around 20% market share (behind market leader YPF (NYSE: YPF) at 55%).

At an estimated 7% EBITDA margin for 2018, Raizen is paying less than 4x forward EBITDA – a meaningful discount to both Cosan SA’s valuation and global multiples for refinery/distribution assets. The deal also includes an agreement with Shell to secure fuel supplies for the stations.

I like this deal. I believe Argentina is in much better shape today and has much sounder economic policies in place, including the liberalization of fuel prices back in the fall of 2017. The integrated model should allow for healthy margins (roughly double those in Brazil) and this should allow Cosan/Cosan SA to benefit from Argentina’s ongoing recovery. I think the deal price reflected, in part, a limited pool of bidders, but there is execution risk here as the Argentine market is a new, different market. Rumo In A Good Place

The changes made to Rumo since Cosan’s involvement have led to meaningful operating improvements in a relatively short time. Replacing aging rolling stock has significantly improved network speeds and operating efficiency, and the company should continue to benefit from macro conditions as the year progresses. Brazil’s agricultural harvest outlook is positive, and the trucking industry continues to see significant headwinds (like higher fuel costs, labor costs, and financing costs), that are keeping freight rates elevated (up 40% yoy in some cases).

Although performance has improved significantly, there are still some positive future drivers. It looks more and more like the renewal of the Paulista concession is a “when” not “if” event. It also sounds as though management is having good success in pushing for more take-or-pay contracts with its major shippers. Last and not least, there are still additional capex investments in the works that can pay dividends; moving to 120 cars/train on the Malha Norte route, for instance, would boost throughput by around 30%. The Opportunity

I expect Cosan SA to hunker down and do what it can during this negative part of the sugar cycle. Management believes it can push ethanol to 70% of its 2018 mix, and ethanol is currently considerably more profitable than sugar. At the same time, management is looking at a wide range of options to reduce mill operating costs, including shuttering operations (at least temporarily) at more expensive mills.