IPO Analysis: Cosan Limited - Sector Outlook Uncertain

Cosan Limited (CZZ) is a leading global ethanol and sugar company in terms of production, with low-cost, large-scale and integrated operations in Center-South region of Brazil, one of the world's most productive sugarcane regions.

Market Position

Sugarcane: Cosan is the largest grower and processor of sugarcane in the world, having crushed 36.2 million tons in fiscal year 2007 and 27.9 million tons of sugarcane in fiscal year 2006 (planted on approximately 572,000 hectares, of which approximately 50% is leased by company, 40% is supplier owned and 10% is company owned);

Ethanol: Cosan is the largest ethanol producer in Brazil and the second largest in the world, having produced 326.7 million gallons (1.2 billion liters) in fiscal year 2007 and 241.7 million gallons (915.0 million liters) in fiscal year 2006, and the largest exporter of ethanol in the world, having exported 72.6 million gallons (274.7 million liters) in fiscal year 2007 and 61.0 million gallons (230.9 million liters) in fiscal year 2006;

Sugar: Cosan is the largest sugar producer in Brazil and one of the three largest sugar producers in the world, having produced 3.2 million tons in fiscal year 2007 and 2.3 million tons of sugar in fiscal year 2006, and the largest exporter of sugar in the world, having exported 2.8 million tons in fiscal year 2007 and 2.1 million tons in fiscal year 2006.

The company operate 17 mills, two refineries, two port facilities and numerous warehouses.

The company significantly expanded its businesses through acquisitions and organic growth, increasing its crushing capacity to 40.0 million tons currently from 13.2 million tons since Cosan's inception in February 2000. From fiscal year 2006 to fiscal year 2007, its net sales increased 53.1% to US$1,679.1 million.

Products

The company mainly produces two products:

Sugar: All varieties.

Ethanol: Hydrous, anhydrous and industrial ethanol.

Other: Electricity generation etc

Revenue

The company generates revenues from:

Sale of sugar and ethanol in domestic and international markets.

Port services provided to third parties.

Sale of Electricity and diesel to agricultural services providers.

Sale of carbon credits.

Segment

The company operates in three segments:

Sugar: Mainly operates and produces a broad variety of sugar products, which are sold to a wide range of customers in Brazil and abroad.

Ethanol: Produces and sells hydrous, anhydrous and industrial ethanol, which are sold primarily to the Brazilian market.

Other products and services: Consists primarily of port services provided to third parties, consumer products under the "Da Barra" brand, electricity sales and fuel diesel sales to agricultural services providers.

Customers

Sugar is sold in domestic as well as export market. Company sell ethanol primarily through gasoline distributors in Brazil mainly at the mill that sell it directly at the pump to customers.

Competition

The sugar industry in Brazil has experienced increased consolidation through merger and acquisition activity during the last several years. Despite this recent wave of consolidation, the industry remains highly fragmented with more than 320 sugar mills and 100 company groups participating. The company faces competition from all these producers. The company also faces competition from international sugar producers

The company also face competition from domestic ethanol producers and also from international producers that use other ethanol sources, such as corn and sugarbeet for the generation of fuel ethanol.

Company's Strength

Size and reach: The company is the third largest producer of sugar in world and sells its products worldwide.

Product switching capacity : The company can switch its product mix between ethanol and sugar according to the market outlook.

Self controlled sugarcane production: Nearly 60% of sugarcane that the company process comes from company controlled fields and this allow company to control the quality of sugarcane produced and thereby quality of end product.

Owned support infrastructure: The company has its own port infrastructure which company use to export it's products.

Strong brand name for domestic market (Brazil): The company primarily sell crystal sugar and amorphous refined sugar in the Brazilian market, mostly under the Da Barra brand name. In fiscal year 2007, it had domestic net sales of sugar of US$158.7 million, which represented 9.5% of it's total net sales.

Financials ($ in million)

Cosan's financial year ends on April 30.

The company has shown significant growth on operational front in last few years, revenue has rise from 644.4 million in FY 2005 to 1679.1 in FY 2007.

Operational income has grown from 90 million in FY 2005 to 232.9 million in FY 2007.

Sugar industry is very much cyclical/seasonal in nature and past performance don't reflect its future outlook. In last one year the sugar sector outlook has totally changed due to shift of demand supply balance in favor of demand where supply is more than demand which leads to a consistent fall of sugar and ethanol prices and with more production capacities coming up all over world the prices are not expected to recover soon.

Company Outlook

The company's future depends upon the price of sugar and ethanol in world market and also to some extent real/dollar exchange rate.

For the short term company's outlook is not that strong due to;

Recent correction in sugar and ethanol prices.

Production is expected to rise further and prices are not expected to recover soon.

Appreciation of real to US dollar.

Company's projection of net loss for itself in FY 2008 is all due to above factors.

Valuation/Offer Balue ($ Iin million)

(These are just assumptions).

At an expected offer price of $17 per share, the company's shares are available at current PE of nearly 14.5** (taking Cosan's" FY 2007 operating profit as base and no tax and interest deduction.)

** Outstanding shares 196,332,044 (company's equity will see very heavy dilution if the existing shareholders of Cosan decide to exchange their share one for one with company's shares and this can add more than 90,000,000 shares to company's existing 196,332,044 shares and thereby will reduce the EPS of company to that extent.)

In FY 2007 the company shows excellent results due to favorable industry conditions, but due to present adverse industry conditions (reasons explained above) it's not possible for company to show same results, in fact company may even struggle to remain profitable, although rising oil prices can push ethanol prices higher.

We rate this IPO 1- on a scale of "1 to 5" (5 for best)

Negatives

Slowdown in industry.

High offer price.

Positives

Due to its size company can handle current adverse industry conditions reasonably well.

Demand of ethanol is picking up due to high crude oil prices.