Tereos : Scrapping of the sugar quota regime: challenge or opportunity?

>Strengths/Opportunities - . One of the first sugar producers in the world (global no.°3 with sales of € 2.2bn in 2016-17, i.e. 46% of sales) with leading positions in countries where it operates (no.°1 in France and the Czech Republic, European no.°3, no.°4 in Brazil). In parallel, Tereos is also one of the leading producers of alcohol and ethanol (overall sales of € 0.8bn) in Europe (no.°1) and in Brazil. The group also diversified into the processing of cereal into starch products (sales of € 0.4bn, no. 3 in Europe) and other by-products.. Broad geographical spread owing to an international strategy launched around 20 years ago. In 2016-17 Tereos generated 25% of its sales in France, 43% in the rest of Europe, 13% in Brazil and 19% in the rest of the world. The scrapping of the sugar quota regime in Europe on 1 October 2017 will open up new export opportunities for the group.. Rebound in earnings in 2016-17 (+38% EBITDA) and improvement in credit metrics (net debt-to-EBITDA ratio of 4x at end-March 2017 vs. 4.7x prior year), buoyed by the rise in world sugar prices, increased production in Brazil and by the performance plans that help improve profitability. For the current year, management anticipates a further uptick in EBITDA (+1 to 6%), factoring in the fall in sugar prices since the beginning of 2017.. Further opportunities with the scrapping of the sugar quota regime in Europe. From 1 October 2017, European producers will no longer be subject to constraints in terms of production and prices. The deregulation will promote competition and probably push down sugar prices. Tereos braced itself by securing over 19 million tonnes of sugar beet in France (an increase of more than 25%) which will result in a significant increase in its production, enabling it to reduce unit production costs (scale effects) and thus becoming more competitive to make market share gains in Europe (since lesser efficient producers will likely be forced out of the market) and in the rest of the world (end of restrictions on European exports). Weaknesses/Threats - . No debt reduction in recent years. Debt levels even increased in 2016-17 (to € 2.4bn, following the acquisition of Petrobras’ stake in Guarani for € 197m) and the recent improvement in the net debt-to-EBITDA ratio derived solely from the upswing in EBITDA. Tereos aims to lower its leverage to 2.5-3x in the medium term, while acknowledging that it cannot commit to a precise timeframe for achieving this ratio target.. More volatile profitability. The group's EBITDA margin stands at around 13% currently, after bottoming out at 10% in 2015-16 vs. 17% on average between 2010 and 2014. With the expiry of the sugar quota regime, margins in the Sugar Europe division are unlikely to return to heyday levels (EBITDA margin of at least 20% vs. 10 to 11% currently). This thus increases the group's exposure to profits from the Sugar International division which is itself more sensitive to changes in world prices and the Brazilian currency. In 2016-17, Sugar International's EBITDA rebounded by 50% (+38% excluding currency effects), whilst the division's sugar production only grew by about 15% and alcohol-ethanol production fell by 9%.. Complex balance sheet structure, although significant headway has been made with the delisting of Tereos Internacional and the acquisition of Petrobras' stake in Guarani in 2016. Oddo Securities recommendation - All in all, the TEREOS bonds due in 2020 (YTW of 0.7% with a call date in March 2019) and 2023 (YTW of 3.1% with a call date in 2023) are trading at wider spread levels than most "BB" rated peers. We recommend the TEREOS bonds in a buy-and-hold strategy given their discount relative to peers and as we do not expect a significant change in Tereos' medium-term credit profile which should therefore maintain its 'BB' credit ratings at S&P and Fitch.