We recently downgraded Cosan Limited (CZZ), Brazilian sugar and ethanol producer, to an Underperform recommendation. The stock was previously rated Neutral.
Cosan, the largest sugar and ethanol producer in Brazil, ranks third in sugar and fifth in ethanol production in the world. Apart from its core operations, the company is also engaged in energy production from sugarcane bagasse and fuel distribution.
Cosan’s first quarter 2012 results were encouraging as revenue jumped 29.7% year over year, while its net income increased substantially, due primarily to the formation of Raizen.
Raizen is Cosan’s recently formed joint venture with Royal Dutch Shell plc (RDS.A). The company expects Raizen to enable it better access the ethanol consumer market and eventually lead to increased competitiveness in biofuels and fuel distribution businesses. Moreover, the joint venture will be one of the largest ethanol producers in the world with 2.2 billion litres of annual production capacity.
Furthermore, Cosan, over time, has been growing through acquisitions and other expansion strategies. We believe the company is well positioned to benefit from its Jataí mill, one of the Greenfield projects.
However, the positive momentum faces headwinds from a highly cyclical industry, intensive competition and sensitiveness of Cosan to domestic and international changes in supply and demand. Further, lowered guidance for Raizen Energia coupled with fears over rise in cost of sales is disconcerting.
Further, Cosan, ending its first quarter of 2012, revised its guidance downward for full fiscal year 2012. At mid-points, crushed cane volume guidance was lowered by 6.0% and sugar volume sold at 6.8%; differing from the respective prior guidance. The revision was made on the basis of dry weather conditions in the Brazilian Center South region, affecting sugarcane production.
In the quarter, cost of goods, as a percentage of revenue, soared 60 basis points to 88.7% and also registered a 30.6% increase on a year-over-year basis. Gross margin in the quarter was 11.3%.
Thus, anticipating a lack of positive catalysts in the quarter ahead, we have downgraded Cosan to an Underperform recommendation.
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