: Tereos: Recent sugar rush will bring another credit upgrade

We initiate the coverage on Tereos, a global sugar producer with operating footprint in Europe and Brazil. The credit is rate d by S&P and Fitch as BB- and BB, respectively with stable outlook. Overall, on the fundamental side we think that risks are skewed to the upside. W e view positively (i) the company’s leading, # 2 , position in the global sugar market and #2 or #3 position in regional markets, (ii) favorable sugar market trend with negative net supply over the last 4 years , (iii) limited capacity of sugar producers to increase acreage across the world, which limits potential supply shocks, (iv) ability to make arbitrage between ethanol and sugar production, (v) diversity of the top line between sugar, ethanol, alcohol and sweeteners, (vi) a thorough internal hedging policy, (vii) strong momentum in earnings growth, (viii) longstanding relationships with clients, and relatively high switching costs, (ix) a significant progress on deleveraging recently and a target of 3.0x for net leverage, (x) energy sufficient plants in Brazil. On the other hand, we are concerned by (i) exposure to volatile commodities (sugar and ethanol), and the fact that sugar prices are currently at a 10-year peak, (ii) high operating leverage and elevated maintenance capex as both amplify volatility swings related to sugar price, (iii) extensive WC swings due to hedging policy and volatility of inventories such as in FY2023, (iv) regulatory changes in Brazil, India, Europe, Thailand and some other major producers might significantly influence the market, (v) worsening climate conditions put pressure on future crop yield (albeit partially will be offset by higher sugar prices), (vi) exposure to natural gas in Europe (albeit offset by some hedging and availability of alternative sources). The credit rating upgrade by S&P is a high probability event , in our view, as leverage has significantly reduced, the sugar market dynamics are rather favorable over the next years, and commercial strategy of Tereos has been extremely successful recently . The current spread of 2028s is 20bps below the average €BB-, or +55bps above €BB s . Even considering the potential upgrade by S&P to €BB, we think that the potential for further tightening is low as the credit has a cyclical component , which should be compensated . In our view, the 2028s and 2027s notes should continue to trade in line or slightly above average €BB spread if sugar prices remain at current high level , which is our base case scenario . W e recommend to Market W eight the Tereos 2028 and 2027 N otes.