São Martinho

Leandro Fontanesi
Agribusiness
23 September 2019
19.280000000000

Turbocharged - Assuming Coverage

with Outperform
 São Martinho is a positive sugar cycle story (S&E worth R$23.00/shr in DCF), with global 140
sugar stock-to-use projected to fall 270bps in 2019/20, turbocharged by the company’s 135
corn ethanol project (R$2.50/shr) and receivables from Copersucar (R$3.50/shr).
130
 We expect São Martinho’s recently-announced corn ethanol project to be approved by
125
YE19 (adding 15% to ethanol production by 2021; reducing risk/volatility), a strategy
120
that we believe could not be implemented by more than 8% of Brazil’s S&E mills.
115
 Following the first Copersucar payment to São Martinho in 1Q19 CY, we incorporate in
our base case the remaining R$1.2bn (next payment expected in 1Q20 CY). 110

 Assuming coverage with a SOTP YE20 TP of R$29.00 (51% upside). The S&E operation 105
is trading at 4.4x 2020 EV/EBITDA, below the historical average of 5.5x. 100
95
A twin-turbo Outperform. We still see room for São Martinho’s stock to price in an upswing in
the sugar cycle in 2019/20 (lower production in the EU/India and a still-high ethanol mix in Brazil), 90
Sep-18 Dec-18 Mar-19 Jun-19
as we forecast sugar prices at US$13¢/lb for 2019/20 (spot @ US$11c/lb), while we believe the
market is pricing in US$11-12¢/lb. Also, this positive cycle story should be turbocharged with
investors pricing in: (i) its corn-based ethanol project (we assume approval by YE19), which our São Martinho IBOV
deep dive shows could be worth R$2.50/SMTO3; and (ii) the remaining R$1.2bn (post-tax) to be
received from Copersucar’s S&E-related legal receivables (R$3.50/share) over the next six
years (we assume the next R$191mn payment will be received in 1Q20 CY). Our SOTP YE20 Ticker: SMTO3 BZ
TP of R$29.00 also implies upside of 51%. We estimate that São Martinho’s S&E operation is Rating: Outperform
trading at a 2020 EV/EBITDA multiple of 4.4x, below the historical average of 5.5x. Target: R$29.00
We expect the sugar cycle to become positive in 2019/20. We forecast the global sugar Upside: 51%
stock-to-use ratio falling to 34% in 2019/20, from 36% in 2018/19, which we model could lead to
7% higher sugar prices in 2019/20 vs. 2018/19 (sugar is ~30% of SMTO’s revenue). This is due
to: 1) Brazil keeping a high ethanol mix for the 2019/20 crop (reaching maximum ethanol mix of (R$ mn) 2018A 2019E 2020E
~65% on attractive prices vs. sugar); and 2) lower-than-expected rainfall in the EU/India, leading EPS (R$) 0.90 1.90 2.22
to 4% lower global production in 2019/20. Despite the sizeable ethanol mix, São Martinho’s
EBITDA 1,645 1,701 2,023
strategy of carrying lower ethanol inventories during the inter-crop season (we estimate 58% of
volumes for 2019/20, vs. ~65% in the 2018/19 crop) reduces the risk of oversupply. As for the P/E 21.5 10.2 8.7
upside risk from the recent attack on Saudi oil facilities, in a sensitivity analysis, for each US$5 EV/EBITDA 5.6 5.2 4.4
increase in our 2020 Brent price estimate of US$65, we would raise our 2020 EBITDA by 5%.
P/BV 2.0 1.7 1.5
São Martinho’s recently announced corn-based ethanol project not yet priced in. The
Dividend Yield % 2.7% 1.6% 2.5%
company announced in June the intent to invest in corn-based ethanol; we view this project as
accretive because: 1) it increases ethanol production by 15% in 2021/22 (assuming it takes 1-2
years to be built); and 2) reduces volatility/risks for the company (with a low correlation between
sugar and corn prices). We believe SMTO has an edge to explore corn-based ethanol (via its Key Figures 23-Sep-19
mill in Goiás state), given that it could benefit from: 1) 20% cheaper corn acquisition vs. São
Local Price (R$) 19.19
Paulo mills; 2) cogeneration from its S&E operation; and 3) state tax benefits. We estimate that
of the 400+ S&E mills in Brazil (Figure 9), only 8% would have similar capabilities to explore corn Price Range - 52 wk (R$) 17.25 - 20.75
ethanol that SMTO has. We see the project’s IRR at ~30% for São Martinho assuming 2-year
Shares Outstanding (mn) 351
capex of R$350mn in real terms, with no major impacts to financial leverage.
3-month ADTV (R$mn) 11.7
Copersucar’s legal receivables are worth R$3.50/shr, with the next payment expected in
1Q20 CY. From March 1985 to October 1989, the Sugar and Alcohol Institute (IAA) adjusted Market Cap (R$bn) 6.8
production costs at rates above those of the FGV (the regulatory index). As a result, Copersucar EV (R$mn) 8,792
filed a lawsuit on behalf of its members and, because São Martinho was part of this cooperative
at that time, it is entitled to a 13% share of the R$18.7bn (pre-tax) in legal receivables. As shown P/BV 2.0
on page 11, São Martinho is expected to receive ~R$365mn per year over the next six years. Current Net Debt (R$mn) 2,556
Having received R$106mn during the 2018/19 crop (1Q19 CY), we incorporate the remaining
Net Debt/2019 EBITDA 1.2
payments in our TP.
Risks to our call: (i) Sugar prices failing to meet our US$13¢/lb estimate for 2020, (ii) Brent
prices falling below our US$65/bbl projection for 2020, (iii) São Martinho’s board not approving
the corn-based ethanol project, and (iv) the government defaulting on Copersucar payments.
Leandro Fontanesi Vicente Falanga Tiago Mello
[email protected] [email protected] [email protected]
+55 (11) 3847 9288 +55 (11) 3847 9471 +55 (11) 3847 9468

Bradesco S.A. Corretora de Títulos e Valores Mobiliários (Bradesco BBI) does and seeks to do business with companies
covered in its research reports.As a result, investors should be aware that Bradesco Corretora and its affiliates may have
a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision. For full disclaimer and definitions, please refer to the end of this report.
COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

Turbocharged – Assuming Coverage with Outperform

We are assuming coverage of São Martinho with an Outperform and a SOTP DCF-
derived YE20 TP of R$29.00, implying 51% upside. Our TP considers: i)
R$23.00/SMTO3 for São Martinho’s Sugar & Ethanol operation; ii) R$2.50/SMTO3 for
its recently announced corn ethanol project (we expect approval by the board by
YE19); and iii) R$3.50/SMTO3 from ~R$1.2bn in Copersucar legal claims to be
received in the next six years (we assume the next payment in 1Q20 CY). We estimate
that São Martinho’s S&E operation is trading at 4.4x 2020 EV/EBITDA, below its
historical average of 5.5x.

Figure 1: SMTO TP Composition (R$/share) Figure 2: Historical EV/EBITDA for São Martinho’s S&E Operation
7.0x

3.50 6.5x
2.50
6.0x

29.00 5.5x 5.5X

23.00
5.0x

4.5x

S&E Operation Corn Ethanol Copersucar Target Price 4.0x

Legal Claims Apr-12 Apr-13 May-14 Jun-15 Jul-16 Jul-17 Aug-18 Sep-19
Source: Bradesco BBI Source: Bloomberg, Bradesco BBI and company data

We have developed three different scenarios for SMTO’s case. In Figure 3, we lay out
our main assumptions. In our bear case, we see SMTO3 at R$17/share (11% downside
to current price); (ii) in our base case, R$29/share (51% upside); and (iii) our bull case
is São Martinho’s stock reaching R$38/share (98% upside).

Figure 3: Scenario Analysis for SMTO3

Scenario Assumption Target Price

In our Bear Case, we incorporate the main possible risks to our call. We assume (i)
the corn ethanol project will not be approved by the board and (ii) all further R$17.00/share
Bear Case
Copersucar payments will be defaulted by the government. In this scenario we Downside: 11%
assume Brent prices at US$60/bbl and sugar prices at US12¢/lb, for 2019/20.

Our Base Case consists of São Martinho's S&E operation valued at R$23/share,
while valuing the corn ethanol project at R$2.50/share and assuming only the 1st R$29.00/share
Base Case
and 2nd IAA tranches will be paid (+R$3.50/share). We assume for 2019/20 Brent Upside: 51%
prices at US$65/bbl and sugar at US13¢/lb.

In our Bull Case, we see (i) São Martinho receiving the controversial amount of the
IAA legal claims, (ii) the "Produzir" tax benefit for ethanol producers in Goiás being R$38.00/share
Bull Case
renewed for 2033 onwards and (iii) Brent and sugar prices at US$70/bbl and Upside: 98%
US14¢/lb, respectively for 2019/20.

Source: Bradesco BBI

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

2019/20 Sugar Deficit Likely to Lift Prices Higher

We expect a cyclical upturn for sugar prices in 2019/20 (sugar currently accounts for
~33% of São Martinho’s total revenue), although the recovery should be gradual given
the time necessary to reduce current world inventories at 68mn tons (stock-to-use of
36% in 2018/19 to fall to 34% in 2019/20). We estimate a 4.6mn ton deficit, from a
surplus of 3.8mn ton in 2018/19 and expect global production to decrease 4% YoY to
171mn tons.

Figure 4: Stock-to-use ratio to fall 270bps in 2019/20 and lead to 7% higher prices

36%
34% 34%
31%
28%
26% 26% 24%
20%
13% 14%

24.5 25.4
21.1 19.6 19.6
16.9 15.4 13.4 13.9 12.1 13.0

2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20e

Sugar Prices (c/lb) Stock to Use Ratio (%)

Source: Czarnikow, Bloomberg and Bradesco BBI

This is due to: (i) Brazil (accounting for 17% of total sugar production) maintaining a
high ethanol mix in the current 2019/20 crop (we estimate 35%, vs. 42% on average
for the last five years due to 5% higher ethanol prices vs. 2018/19, while sugar
remained flat YTD); and (ii) India and the European Union having been impacted by
lower-than-expected rainfall (accounting for 19% and 10% of global sugar production,
respectively).

Figure 5: We forecast a 4% decrease in global sugar production in 2019/20 with high ethanol mix in Brazil and lower rainfall in the
EU/India (mn tons)

188.6
177.4
166.1 170.6

39.2 38.9
34.3 33.1
29.5 30.0 29.0
22.2 20.8
18.3 18.2 17.5

2016/17 2017/18 2018/19 2019/20e

Brazil European Union India World

Source: Czarnikow, USDA, Bloomberg and Bradesco BBI

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

We forecast that this scenario should lead to sugar prices of US$13¢/lb in 2019/20 (vs.
US$12¢/lb in 2018/19 and spot of US$11¢/lb), reversing the decrease of 8% in sugar
prices YTD. We estimate that the stock is pricing in conservative sugar prices of
US$11-12¢/lb for 2019/20, which implies in 20% upside for São Martinho’s S&E
operation at a DCF-derived NPV/shr of R$23.00. For each 10% increase in our sugar
price forecast for 2020, we would raise our 2020 EBITDA by 6%.

Following ethanol market dynamics, and unlike the 2018/19 crop, we expect ethanol-
gasoline parity to reach the 70% mark in the intercrop period. In the last three harvests,
the sector sold on average 31% of its respective ethanol production in the intercrop
period, but in the 2018/19 harvest, most players shifted sales even more to the
intercrop period (36%) on the back of higher Brent price expectations and ethanol
consumption. Consequently, parity failed to meet the 70% mark due to weak prices.

For the 2019/20 crop, we expect the sector to be more risk-averse, and closer to its
historical behavior. All in all, we estimate ethanol prices for São Martinho at R$1.9/L in
2019/20 and R$2.0/L in 2020/21.

Figure 6: Ethanol vs gasoline parity in Brazil (intercrop period in red)

80%

75%

70%

65%

60%

55%
Jan/13 Aug/13 Mar/14 Oct/14 May/15 Dec/15 Jul/16 Feb/17 Sep/17 Apr/18 Nov/18 Jun/19

Source: Bradesco BBI and ANP

For the 2019/20 crop, we assume a 40%/60% sugar/ethanol mix. Although SMTO
did not guide the market on its sugar/ethanol mix for the current 2019/20 harvest, we
assume a 40%/60% sugar/ethanol mix in the full crop year. Our estimate for São
Martinho is based on both (i) São Paulo mill’s average mix of 42%/58% S&E up until
September 2019 (three of the company’s four mills are located in São Paulo state) and
(ii) the reported 1Q20 mix for SMTO of 41%/59% S&E (which, historically, has fairly
represented the full harvest mix for the company).

We understand that in the long term, ethanol and sugar should yield similar profitability,
which is why we settle at a 50%/50% mix in 2029/30. We point out that this mix does
not incorporate the corn ethanol project, but if we were to take it into account, the
ethanol mix would rise to ~55%.

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Bradesco BBI Equity Research
23 September 2019

Figure 7: We Assume a Still High Sugar Ethanol Mix in 2019/20

57% Ethanol Sugar

54%

50% 50% 50% 50% 50% 50% 50% 50% 50% 50%
49%
48% 64%
47%
60% 45%

55%
53% 40%
52% 51%
50% 50% 50% 50% 50% 50% 50% 50% 50% 50%
36%
46%
43%

2012/13 2014/15 2016/17 2018/19 2020/21 2022/23 2024/25 2026/27 2028/29

Source: Company data and Bradesco BBI

The recent impact of a drone attack in Saudi Arabia makes us more confident
with the high ethanol mix in Brazil and may bring further upside for ethanol
prices. As flagged by Bradesco BBI’s Oil & Gas team (link to report) on Sep 16, a key
Saudi processing plant suffered coordinated drone attacks, impacting 5.7mn of the
Kingdom’s oil output (6% of global demand). While the country’s oil ministry said on
Sep 17 that Saudi Arabia will soon restore most of its oil output and fully recover within
weeks, we have analyzed possible scenarios if Brent prices were to remain at a higher
level. For each 10% increase in our Brent prices forecast for 2020 (US$65/bbl), we
would raise our 2020 EBITDA by 7%.

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

Corn Ethanol Is Worth R$2.50/SMTO3

São Martinho announced on June 2019 a letter of intent to invest in corn-based ethanol
production at their Boa Vista mill (UBV), located in the Brazilian state of Goiás. We
welcome this initiative by the company, and estimate the project could add
R$2.50/share for SMTO3 (upside potential of 13%).

The project adds value by increasing São Martinho’s total ethanol production by 15%
in 2021/22 on accretive terms, as the company can take advantage of (i) lower corn
prices in Goiás mill vs. São Paulo mills, (ii) tax incentives that provide a premium to
ethanol prices, and (iii) access to cogeneration from its S&E operations. On top of that,
when added to São Martinho’s S&E ethanol operation, it should reduce risks/volatility,
in light of the low correlation between sugar & ethanol and corn prices.

Five reasons why corn makes sense for São Martinho

#1 São Martinho has access to 20% cheaper corn by its Goiás mill vs. São Paulo
mills. São Martinho’s Goiás mill (UBV) is geographically well positioned inside the
state, very close to key corn producing regions. Not only does Goiás produce 10% of
Brazil’s corn (making it the third-largest state in terms of output), but its main corn-
producing counties (Rio Verde, Jataí, and Montividiu that account for 45% of the state’s
corn production) are, on average, just 165km away from UBV. We estimate that UBV
should be able to acquire corn at a 20% discount in comparison to its São Paulo mills.

#2 São Martinho can take advantage of Goiás state’s tax benefits. The Goiás State
Government currently holds local tax measures to incentivize the production of ethanol
and other products. By providing certain sectors with relief from ICMS tax, São
Martinho’s UBV now receives a 73% rebate on its ICMS liability. It is also worth pointing
out that the program will last until Dec. 2032, which is reflected in our base case.

#3 Access to S&E operation’s cogeneration capacity. São Martinho’s Boa Vista

mill is able to produce electricity from sugarcane bagasse for more than enough to
supply the corn ethanol project. We estimate that the required amount for this corn
ethanol project would be ~8% of São Martinho’s 2018/19 energy sales. This aspect of
the project is highly relevant, as the absence of electricity production would require the
mill to invest in a eucalyptus forest for biomass production, and/or in cogeneration
technology (in the case of a sugarcane operation, the instalment of a cogeneration
boiler would add another ~R$200mn in capex), which could result in lower returns for
the project.

#4 Large potential market for corn-based ethanol byproducts in Goiás. The two
main byproducts of corn-based ethanol production are dried distillers grains with
solubles (DDGS, used mainly as animal feed) and corn oils. Because Goiás accounts
for 11% and 5% of Brazil’s total cattle and hog herds, respectively, we see the state as
a strong potential market for DGGS, which makes up as much as 20-30% of feed.

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Bradesco BBI Equity Research
23 September 2019

#5 The low correlation between the Consecana sugar index and corn prices
reduces risks/volatility for São Martinho. The company has exposure to risks such
as FX, sugar, Brent, and weather, and by including corn in its portfolio, we see better
risk management due to the low correlation between the assets. Since the Consecana
index is calculated on top of sugar and ethanol prices, and the latter is influenced
(among other factors) by Brent and FX, we believe the Consecana index would be a
fair proxy for SMTO’s current risk portfolio. Assuming prices in real terms, we estimate
a -3% correlation between Consecana and Rio Verde’s corn prices.

Figure 8: Consecana vs Corn Prices in Real Terms

30
Consecana prices (R$/kg of TRS; RHS)
28 0.40

26
0.35
24
22
0.30
20
18
0.25
16
14 0.20
12 Corn Prices (R$/60 kg bag; LHS)
10 0.15
Jul/04 Dec/06 Jul/09 Dec/11 Jul/14 Dec/16 Jul/19

Source: Bloomberg and Bradesco BBI

São Martinho’s São Paulo mills unlikely to implement corn ethanol projects. First,
of the three São Paulo mills, only USM has cogeneration technology, and it does not
need incremental capex investments for electricity production. Second, due to the
significant distance from major corn-producing regions in Brazil, we estimate that corn
prices would be 25% higher than UBV’s due to freight costs. Lastly, there is no tax
benefit for ethanol in São Paulo. If we were to model the exact same project for the
São Martinho mill, but assuming: (i) no ICMS tax exemptions and (ii) corn prices at
R$36/60kg bag, the project would yield a negative NPV. In addition, we believe this
scenario could be worsened by lower demand for DDGS.

We estimate that only ~8% of Brazil’s ethanol mills would have similar
capabilities as São Martinho’s to explore corn ethanol and are not in Chapter 11
proceedings. According to NovaCana, there are 410 ethanol mills in Brazil. However,
we believe that only the states of Mato Grosso, Mato Grosso do Sul and Goiás, which
combined account for 74 of Brazil’s total number of mills, offer advantages for corn-
based ethanol, such as: (i) low corn prices; (ii) tax incentives and (iii) a sizable cattle
herd. However, we estimate that 1/3 of these mills are facing financial challenges,
which may limit their ability to invest in corn-based ethanol, and, of the remaining, 34
have access to S&E cogeneration and have the potential to develop corn-based
ethanol.

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

Figure 9: We estimate that no more than ~8% of Brazil’s ethanol mills would have capabilities
similar to São Martinho’s to explore corn-based ethanol and are not in Chapter 11 proceedings

Sugar & Ethanol mills In Brazil – 410

With access GO / MT / MS / MG / PR – 146

to cheap corn

With tax incentives GO / MT / MS – 74

+ high feed demand

Are not in Chapter 11 49

proceedings

Have cogeneration 34

Source: NovaCana, IBGE, Bloomberg, and Bradesco BBI

How to Model São Martinho’s Corn Ethanol Project

Using a DCF-based valuation, we value the corn ethanol project at R$797mn

(YE19/20). When valuing the project, the most value-sensitive drivers are: (i) corn
conversion efficiency into ethanol and DDGS (by-product used mainly for animal feed),
(ii) Goiás State tax benefit (Produzir), (iii) corn acquisition costs, and (iv) capex. We
believe that in order to proper value the operation, a few assumptions and sector-
specific drivers need to be explained.

(i) 1ton of corn yields 400L of ethanol and 280kg of DDGS: In line with São
Martinho’s announcement to the market and other corn-based ethanol
benchmarks, we assume that for each ton of crushed corn, 400L of ethanol
and 280kg of DDGS will be produced. In the case of SMTO working at full
capacity (total crushing of ~500k tons of corn per year), we believe the project
would increase São Martinho’s ethanol production capacity by 15%. All in all,
we estimate the operation’s kick off at 2021/22 with capacity utilization at 75%
(an incremental 15% in ethanol production to a 50%/50% S&E mix).
Thereafter, we assume capacity utilization at 95%.

(ii) Prices and tax benefits: The “Produzir” tax benefit stablishes that most
ethanol producers are exempted of the equivalent to 73% of the ICMS tax rate.
For 2021/22 harvest, we estimate net ethanol prices at R$2.7/L. On the other
hand, we estimate prices for DDGS, the main byproduct from corn crushing,
to have a 12% discount to corn prices. In a sensitivity analysis, if we were to
assume DDGS sales are cut in half, the project’s NPV would decrease by 45%.
We see prices in 2021/22 at R$0.50/kg.

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Bradesco BBI Equity Research
23 September 2019

Figure 10: DDGS Prices in the US vs. Corn CBOT Prices

350
200%
Corn Prices (USD/ton) 300

150%
250
DDGS Prices (USD /ton)
100% 200

150
50%
100
DDGS discount to Corn Prices (%; LHS)
0%
-12% 50

-50% 0
Jan-10 Sep-10 May-11 Jan-12 Oct-12 Jun-13 Feb-14 Oct-14 Jun-15 Mar-16 Nov-16 Jul-17 Mar-18 Nov-18 Aug-19

Source: Bloomberg and Bradesco BBI

(iii) Corn acquisitions costs: The project would breakeven at a corn price of
R$41/60kg bag, ~45% above current prices. All in all, we estimate total corn
prices in Quirinópolis by adding to Rio Verde’s (county that accounts for ~18%
of Goiás’ corn production) corn prices, freight costs (R$50/ton). For the coming
years, we assume corn prices will vary in line with its future curve. All in all, we
believe that if corn prices reach ~R$41/60kg bag, the project’s breakeven
would be reached.

Figure 11: Project NPV vs Corn Prices in Rio Verde (R$ mn)

Corn Prices (R$/60 kg bag)

797 19 25 30 36 41
7% 3,041 2,251 1,462 672 -234
8% 2,133 1,585 1,038 490 -129
Ke 9% 1,630 1,214 797 381 -83
10% 1,307 973 639 305 -63
11% 1,080 803 525 248 -55

Source: Company; Bloomberg and Bradesco BBI

(iv) Capex: The total capex investment of R$350mn (diluted in two years) would
yield a ~30% IRR. Following São Martinho’s capex investment guidance of
R$350mn, we assume disbursement will be divided into two sequential
instalments of: (i) R$30mn in the current 2019/20 crop and (ii) R$320mn (91%
of total investment; in real terms) in 2020/21.

Risks to our call: the project not approved; high corn prices; low efficiency. The
main risks to our corn ethanol call are: (i) the board not approving the project (we
expect an announcement by YE19); (ii) corn prices rising consistently above the
breakeven mark of R$41/60kg bag; and (iii) ethanol and DDGS conversion failing to
reach the 400L/ton of crushed corn and 280kg/ton efficiency marks, respectively.

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Bradesco BBI Equity Research
23 September 2019

Figure 12: Corn-based Ethanol Project Financials

Financial Statement 2021/22 2022/23 2023/24 2024/25 ... 2032/33 2033/34
Production
Effective Crushing (k tons) 375 475 475 475 475 475
Ethanol (k m³) 150 190 190 190 190 190
DDGS (k tons) 101 128 128 133 133 133
Oils (k tons) 4 5 5 5 5 5

Prices
Ethanol (R$/m³) 2,736 2,871 2,907 2,964 3,119 2,710
Produzir Benefit (R$/m³) 561 588 595 606 502 0
DDGS (R$/ton) 485 503 520 539 712 737
Oils (R$/ton) 1,103 1,142 1,183 1,225 1,617 1,675

Net Revenues (R$ '000) 463,670 615,450 624,702 640,585 694,958 620,886
Ethanol 410,386 545,567 552,345 563,107 592,619 514,924
DDGS 49,148 64,457 66,739 71,661 94,656 98,007
Oils 4,137 5,426 5,618 5,817 7,683 7,955

Expenses (R$ '000) -302,403 -391,444 -397,581 -404,597 -463,926 -478,375

Raw Materials -227,062 -297,793 -308,335 -319,250 -421,692 -436,620
Energy Expenses -15,065 -19,798 -20,530 -21,289 -28,334 -29,337
Other Expenses -60,277 -73,854 -68,717 -64,058 -13,899 -12,418

EBITDA (R$ '000) 161,267 224,006 227,121 235,988 231,032 142,511

EBITDA Margin (%) 34.8% 36.4% 36.4% 36.8% 33.2% 23.0%
Growth 38.9% 1.4% 3.9% -8.8% -38.3%

Depreciation -36,313 -37,598 -38,929 -40,307 -53,241 -55,126

Income Taxes -42,484 -63,379 -63,985 -66,532 -60,449 -29,711

Net Income (R$ '000) 82,470 123,029 124,207 129,150 117,342 57,674
Net Income Margin (%) 17.8% 20.0% 19.9% 20.2% 16.9% 9.3%

Balance Sheet
Capex 36,313 37,598 38,929 40,307 53,241 55,126
Maintenance 36,313 37,598 38,929 40,307 53,241 55,126

Source: Bradesco BBI and company data

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

Copersucar’s Legal Receivables Add R$3.50/SMTO3

Copersucar’s legal claims should yield an extra R$3.50/share for SMTO3

(reflected in our base case). Over the next 6 years, we model São Martinho receiving
up to R$1.2bn (in nominal terms, after taxes), with an upside potential for an additional
R$162mn. Discussions are still under way about how taxation will occur and whether
the controversial amount is owed. The company received its first payment from
Copersucar’s legal claims in 1Q19 CY (~R$106mn).

1) A quick recap on how it all started

São Martinho has a 13% stake in Copersucar’s R$18.7bn in legal claims. From
March 1985 to October 1989, the Sugar and Alcohol Institute (IAA) adjusted production
costs at rates above the FGV index’s. The Brazilian Sugar and Alcohol Cooperative
(Copersucar) filed a lawsuit on behalf of its members and, because São Martinho was
a part of Copersucar at the time, the company is currently entitled to a 13% stake in
the R$18.7bn legal claim (which totals R$2.4bn, before taxes).

2) Specifics on the payment schedule and tax discussions

São Martinho has already received R$106mn, and is up for R$336mn in 2019/20.
We believe that the market has not yet priced in the receivables due to uncertainties
linked to the possibility of default by the Brazilian government. We see a default
scenario as low risk since the first due amount was paid 4Q19, hence, incorporating in
our TP. Of the whole amount of the legal claims, 88% has been considered
uncontroversial (a total of R$2.1bn for SMTO, before taxes), while the remaining 12%
is still under discussion due to index adjustment issues. We estimate after taxes inflow
for 2019/20 of R$191mn (to be paid in 1Q20 CY).

The uncontroversial amount of 88% will be paid in two tranches, both in 6 years
instalments (15% in the first crop year and 17% in each of the remaining years). To be
conservative, we incorporate in our assumptions a 34% income tax rate and a 9.25%
PIS/COFINS tax rate.

Figure 13: Payment Schedule for Copersucar’s Legal Claims (R$ mn before taxes)

365 365 365 365

336

241
213 241 241 241 241

106
241

106 124 124 124 124 124

2018/19 2019/20 2020/21 2021/22 2022/23 2023/24 2024/25

1st Tranch 2nd Tranch
Source: Company data and Bradesco BBI

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

Relative Valuation

We are assuming coverage of São Martinho with an Outperform rating and a SOTP
YE20 DCF-derived target price of R$29/share (51% upside to the current price), using
an ~8% WACC and a 4.5% perpetuity growth rate. In our estimates, we see SMTO’s
S&E operation trading at 4.4x 2020 EV/EBITDA, below its historical multiple of 5.5x.
Our base case also considers the upside coming from the Copersucar legal
receivables (R$3.50/SMTO3) and São Martinho’s recently announced corn ethanol
project (R$2.50/SMTO3).

Figure 14: LatAm Agricultural Peers Comp Table

Mkt Cap TP ADTV EV/EBITDA P/E ROE Div. Yield ND/EBITDA
Rating
(US$mn) (Local Curr.) (US$mn) 2019E 2020E 2019E 2020E 2020E 2020E 2020E

São Martinho 1,626 29.00 OP 4 5.2x 4.4x 10.1x 8.6x 17% 2% 1.0x
Cosan 5,041 58.00 OP 22 7.1x 6.6x 15.9x 14.2x 12% 4% 2.8x
Adecoagro 733 - U.R. 2 5.4x 4.5x 13.3x 8.6x 11% 2% 1.7x
SLC Agricola 842 16.00 UP 6 6.4x 9.1x 10.6x 16.6x 8% 5% 2.1x
BrasilAgro 242 - U.R. 1 6.6x 9.9x 7.7x 12.1x 9% - 1.3x
LatAm Agribusiness 8 6.4x 7.5x 11.9x 12.9x 10% 3% 2.0x

Source: Bradesco BBI and Bloomberg

We forecast 2019 and 2020 net revenue in line and 4% higher than consensus,
respectively, as we believe the market is too conservative on sugar prices (we forecast
US$13¢/lb in 2019/20, while we estimate that the stock is pricing in US$11-12¢/lb). On
the other hand, our EBITDA forecasts are 8% below and 1% above consensus for
2019 and 2020, respectively, highlighting our cyclical improvement in commodity
prices for 2020. In line with our more bullish forecasts for sugar and incorporation of
Copersucar’s receivables (booked after EBITDA), our net income estimates are
R$665mn and R$778mn for 2019 and 2020, respectively, while consensus is at
R$525mn and R$523mn.

Figure 15: BBIe vs. BBG

BBIe vs. BBG - 2019 BBIe vs. BBG - 2020
São Martinho
BBI BBG BBI vs. BBG BBI BBG BBI vs. BBG
Net Revenues 3,646 3,632 0.4% 4,086 3,944 3.6%
EBITDA 1,701 1,847 -7.9% 2,023 2,004 1.0%
EBITDA margin 47% 51% -4.2p.p 50% 51% -1.3p.p
Net Income 665 525 26.7% 778 523 49.0%

Source: Bradesco BBI and Bloomberg

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

São Martinho at a Glance

São Martinho is one of the largest sugar and ethanol producers in Brazil, with a total
milling capacity of 24.5mn tons of sugarcane. The company’s history dates back to the
early 20th century, when the Omettos, a family of Italian immigrants, set up their first
sugarcane mill in 1914 in Limeira (Sao Paulo state). Since 2007, São Martinho’s stock
has been listed on the Novo Mercado, the highest corporate governance index of the
São Paulo Stock Exchange (Bovespa).

The company owns four mills: São Martinho (the world’s largest sugarcane processing
facility), Santa Cruz, Boa Vista, and Iracema, located in the states of São Paulo and
Goiás. The São Martinho, Santa Cruz, and Iracema plants produce both sugar and
ethanol, while Boa Vista is dedicated exclusively to ethanol production. The company
also generates energy by burning bagasse. Although it consumes most of the energy
it generates, the company also sells the surplus.

Because S&E mills are able to rapidly shift between ethanol and sugar from one
harvest to the other, São Martinho’s recent focus has been on ethanol. In 2018/19, the
sugar/ethanol mix was 36%/64%, compared to 47%/53% in 2017/18 and 54%/46% in
2016/17. Consequently, ethanol currently accounts for a greater portion of revenue
(59% in the 2018/19 crop), as shown in Figure 17.

Figure 16: Ethanol vs Sugar Mix Figure 17: Revenue Breakdown 2018/19

Ethanol Sugar
57% Energy,
54% 64% 6% Others, 2%

49% 50%
48% 47%
Sugar,
52% 53%
51% 33%
50%
46% 36%
43% Ethanol,
59%

Source: São Martinho and Bradesco BBI Source: São Martinho and Bradesco BBI

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 COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

Ownership Structure

Sao Martinho’s controlling shareholder is LJN Participações, which holds a 53.7% stake.
The owners of LJN are different holding companies owned by the Ometto family. The
company’s shares are listed under “SMTO3”, with only one share class (voting common
shares).

Figure 18: Shareholder Structure

LJN
Participações Indirect Treasury and
Free Float
Controllers Admin
(Ometto Family)

53.7% 3.6% 1.1% 41.5%

Source: São Martinho and Bradesco BBI

The company’s board of directors has seven members. Five members are elected by
the controlling shareholders, and the remaining two are independent members.
Members are appointed for a two-year term, and can be dismissed by shareholders in
a shareholders’ meeting. São Martinho’s management team currently comprises 10
executive officers, including CEO and CFO, appointed by the board of directors. Fabio
Venturelli has served as CEO since 2007, and Felipe Vicchiato has served as CFO
since 2014.

Figure 19: Management Team

Name Position Professional Experience

- Serving as chairman of São Martinho’s board of directors since 2018, having accumulated over
Marcelo Campos 35 years of experience in the agricultural sector.
Chairman
Ometto - Previously, he served as CEO of Dimas Ometto Participações.
- Bachelor’s degree in business management from the Univ. of Ribeirão Preto, and other degrees.
- Serving as vice-chairman of São Martinho’s board of directors since 2018.
João Guilherme - Previously, he served as chairman and CEO of São Martinho, as well as in executive positions in
Vice-Chairman
Sabino Ometto Usina São Martinho and Omtek.
- Degree in mechanical engineering from the University of São Paulo
- Serving as CEO of São Martinho since 2007, having accumulated over 25 years of experience.
Fabio Venturelli CEO - Currently serves as a member of the board of directors at Braskem and CTC.
- Degree in production engineering from the USP Polytechnic School, and other degrees.
- Joined São Martinho in 2005 and has served as CFO since 2014.
Felipe Vicchiato CFO/ IRO - Has over 20 years of experience in the financial markets.
- Previously worked at Arthur Andersen, BBVA, and Banco Bradesco.
- Degree in business management from FAAP, and other degrees.
Source: São Martinho and Bradesco BBI

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019

Income Statement
BRL million 2018/19 2019/20e 2020/21e 2021/22e
Net Revenues 3,382 3,646 4,086 5,253
Cost of Goods Sold -2,489 -2,653 -2,927 -3,508
Gross Profit 893 992 1,159 1,745
SG&A -293 -370 -373 -500
Other Expenses 98 402 365 365
EBIT 698 1,024 1,151 1,610
Adjusted EBITDA 1,645 1,701 2,023 2,530
Financial Income/Expense -319 -205 -158 -171
Pretax Income 379 819 993 1,438
Income Tax -65 -154 -214 -371
Net Income 314 665 778 1,067

CAPEX -1,766 -1,492 -1,936 -1,873

Dividends 180 110 166 212
Net Debt 2,402 2,060 2,097 1,754

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019
Analyst Certification

Each analyst responsible for the preparation and content of this report hereby certifies, pursuant to SEC Regulation AC and applicable laws and regulations of other jurisdictions, that:

(i) the views expressed herein accurately and exclusively reflect his or her personal views and opinions about the subject company(ies) and its or their securities;
(ii) no part of his or her compensation was, is, or will be paid directly or indirectly, related to the specific recommendation or views expressed by that analyst in this report; and pursuant to Brazilian
securities exchange commission (Comissão de Valores Mobiliários – CVM) Instruction 598/18:

(i) the recommendations indicated in this report solely and exclusively reflect his or her personal opinions, and were prepared independently and autonomously, including in relation to Bradesco
Corretora and its affiliates;
(ii) his or her compensation is based on the profitability of Bradesco Corretora and its affiliates, which includes investment banking revenues;

Company disclosures pursuant to Brazilian securities exchange commission (Comissão de Valores Mobiliários – CVM) Instruction 589/18:

(i) Banco Bradesco S.A. owns indirectly 5% or more, regading its subisidiaries, of equity securities issued by Cielo S.A. and Fleury S.A.. BRADESPAR S.A., whose controlling group is comprised of
the Same shareholders which control Banco Bradesco S.A., owns 5% or more of equity securities issued by VALE S.A..

(ii) Ágora, Bradesco Corretora, Bradesco BBI and Bradesco Group companies have relevant financial and commercial interests in relation to the subject company(ies) or the subject security(ies);

(iii) Bradesco BBI is participating as Coordinator in the public offering distribution of Banco Inter S.A., Minerva S.A. and Natura Cosméticos S.A..

(iv) Bradesco BBI participated as Coordinator in the public offering of equity and/or debt securities or/ and provided any other type of service for the following companies within the past 12 months:
AES Tiete Energia S.A., Atacadão S.A., B3 S.A. - Brasil, Bolsa, Balcão., Banco Btg Pactual S.A., BRF S.A., Cesp - Companhia Energética De São Paulo, Cielo S.A., Companhia Brasileira De
Distribuição, Companhia De Locação Das Américas - Unidas, CPFL Energia S.A., CSHG Logística - Fundo De Investimento Imobiliário - Fii, Eletropaulo Metropolitana Eletricidade De São Paulo
S.A., Energisa S.A., Engie Brasil Energia S.A., Estacio Participações S.A., Gol Linhas Aéreas Inteligentes S.A., Grupo SBF S.A., Guararapes Confecções S.A., Instituto Hermes Pardini S.A., Iochpe
Maxion S.A., IRB Brasil Resseguros S/A, JSL S.A., Kroton Educacional S.A., Light Serviços De Eletricidade S.A., Localiza Rent A Car S.A., MRV Engenharia E Participações S.A., Multiplan
Empreendimento Imobiliário S.A., Natura Cosméticos S.A., Notre Dame Intermédica Participações S.A., Petróleo Brasileiro S.A., Raia Drogasil S.A., Randon S.A. Implementos E Participações,
Rede D'or São Luiz S.A., Rumo S.A., XP Malls Fundo De Investimento Imobiliário - FII; Hapvida Participações E Investimentos S.A. and Movida Participações S.A.

(v) Ágora and/or Bradesco Corretora participated in the public offering of equity and/or debentures for the following companies within the past 12 months: Banco Inter S.A., Companhia De
Transmissão De Energia Elétrica Paulista (CTEEP), Cyrela Brazil Realty S.A. Empreendimentos E Participações, Direcional Engenharia S.A., Engie Brasil Energia S.A., Hapvida Participações E
Investimentos S.A., Iguatemi Empresa De Shopping Centers S.A., Light Serviços De Eletricidade S.A., Notre Dame Intermédica Participações S.A., São Martinho S.A., Transmissora Aliança De
Energia Elétrica S.A. - TAESA, XP Malls Fdo Inv Imob FII and XP Log Fdo Inv Imob - FII.

(vi) Bradesco Corretora receives compensation for market making in the equity securities of Alpargatas S.A. (ALPA4). Fomento Economico Mexicano FEMSA (FMXB34), Helbor Empreendimentos
S.A. (HBOR3) and Terra Santa Agro S.A. (TESA3).

Important Disclosures
Company-Specific regulatory disclosures
Bradesco Corretora and/or its affiliates beneficially own one or more of any class of common quity securities of the subject company(ies). The position
1
reflects information available as of the business day prior to the date of this report.
Bradesco Corretora and/or its affiliates have managed or co-managed a public or Rule 144A offering of the subject company's(ies') securities in the
2
twelve months preceeding the date of this report

Bradesco Corretora and/or its affiliates have received compensation for investment banking services from the subject company(ies) int the twelve
x 3 monthes preceeding the date of publication of the research report and/or expects to receive or intends to seek compensation for investment banking
services from the subject comapny(ies) in the three months following the date of this report.

4 Bradesco Corretora and/or its affiliates were making a market in the subject company(ies) equity securities at the date of this report.

5 Any other actual material conflict of interest of Bradesco Corretora and/or its affiliates known at the date of this report.

Bradesco Corretora research ratings distribution

Rating Definition Coverage¹ BR²

Outperform Expected to outperform the analyst coverage list 43% 23%

Neutral Expected to perform in the range of the analyst coverage list 51% 19%

Underperform Expected to underperform the analyst coverage list 6% 8%

Under Review This indicates that both the target price and the rating are currently being revised. 0%

Restricted The analyst cannot express his/her views on the company. 0%

(1) Percentage of companies under coverage globally within this rating category. As of 23-Sep-19 Bradesco Corretora had 213 companies under coverage globally.
(2) Percentage of companies within this rating category for which [investment banking] services were provided within the past 12 months.

Bradesco Corretora ratings

Bradesco Corretora ratings are constantly revised and any temporary inconsistencies between the upside potential that gave rise to any such rating and the upside potential in connection with the
target price are at all times deliberate. The official rating shall prevail.

Any differences between the rating and the target price may occur especially due to the analyst’s expectations to the effect that any short/medium term factors that cannot be priced-in yet might lead
to inconsistencies between Bradesco Corretora valuation and the stock behavior. The factors Bradesco Corretora considered include, but are not limited to: Any expectations in connection with
quarterly results, market conditions, ownership issues and any expectations involving mergers and acquisitions. The ratings reflect only the analyst’s expectation on the future performance of the
relevant stock. A “Outperform” rating does not necessarily represent that the analyst approves of the company and its management whilst a “Underperform” rating does not necessarily means that
the analyst has a negative view on the company. Within Bradesco Corretora coverage universe there are sound companies, with good fundamentals as per the market consensus, and fair priced
stock, and would not be Bradesco Corretora investment pick.

Price target and rating history

Price target, rating history chart(s), valuation/method used to determine price target, and our policy for managing conflicts of interest in connection with investment research are available upon
request. You may obtain this information by contacting your representative or by sending an email to [email protected].

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COMPANY REPORT
Bradesco BBI Equity Research
23 September 2019
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