by Debra Fiakas CFA
Last week Cosan Limited (CZZ: NYSE) revealed a decision to delay the spin-off and recapitalization of its natural gas distribution network, COMGAS. Management cited unfavorable capital market decisions. Cosan has a mix of businesses, of which we have been most interested in its Raisen Energia sugar cane agriculture and ethanol production. Raisen is a joint venture with Royal Dutch Shell that was initiated in 2011. The operation squeezes over four million tons of sugar from cane grown in its fields and two billion liters of ethanol each year. The ethanol is sold through Shell’s network of gas stations in Brazil. Raisen has also become player in electricity generation from sugar cane bagasse with 900 megawatts of installed capacity.
CZZ shares have been in a steady decline over the past two years, with only a couple of short-lived attempts at price recovery. There is a good reason for Cosan management to look for strategic solutions. In combination Cosan businesses command a market value of $1.8 billion. I imagine that we were not the only Cosan watchers who wondered whether the sum of the parts might worth well more than the whole.
Perhaps part of the problem is the erosion of Cosan’s image as a ‘clean’ energy company. Cosan shares first began trading on the NYSE in late 2008 and investors warmed immediately to the mix of sugar cane agriculture and ethanol production. The market capitalization of Cosan at the close of trading that first day was $912 million. The company had already achieved profitability and staged its U.S. equity market debut on a strong sales growth and profitability in the year 2007. Sugar and ethanol sales represented 94% of Cosan’s business back then.
Fast forward to present time, Cosan has given up 50% portion of the sugar cane and ethanol operations to shell in the Raisen Energia joint venture and acquired the COMGAS business. Based on the sales Cosan reported in the first nine months of 2014, Raisen’s sugar and ethanol sales fell to 77% of Cosan’s reported revenue and the natural gas distribution business had stepped up to 16% of the mix.
There are of course other factors that could be irritating investors. Cosan’s net profits were dramatically higher in the first nine months of 2014 compared to the same period in the prior year. However, cash operating earnings (EBITDA) grew by only 5.6% year-over-year in large part because Raisen Energia only managed to contribute half of the company’s cash earnings despite being over three quarters of the sales mix. COMGAS on the other hand delivered a 23.8% operating margin in the first three quarters of 2014.
It seems Cosan’s ‘green’ business has given the company a black mark. Management move to break up the company is probably more for the sake of getting its highly profitable (and valuable) natural gas operation out on its own than in burnishing its image as a ‘green’ company.
Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. CZZ is included in Crystal Equity Research’s Beach Boys Index of companies developing alternative energy using the power of the sun.