Adverse Weather Will Weaken Ethanol Margins But Spur Value

Key Takeaways

• Expansion into high-return projects and efficiency initiatives is offset by adverse weather, weak yields, and unfavorable commodity pricing, threatening earnings and margin stability.
  
• Shifting regulations, technological disruption, and evolving consumer preferences could challenge long-term biofuel and sugar market stability, pressuring growth and industry pricing power.
  
• Climate risks, weak sugar and ethanol prices, high capital spending, rising competition, and geographic concentration threaten São Martinho's revenue stability and future earnings.

Catalysts

Engages in the production and sale of sugar, ethanol, and other sugarcane byproducts in Brazil.

• Although São Martinho is investing in operational efficiency and new high-ROIC projects-such as the expansion of corn-based ethanol and integrated warehouses, which could set up stronger, more diversified cash flows-the company faces near-term pressure on earnings and margins from higher input costs, persistently weak sugarcane yields due to adverse weather, and a challenging price environment for both sugar and ethanol that may extend into subsequent quarters.
  
• While global decarbonization and legislative biofuel mandates should support long-term demand for São Martinho's ethanol output, the company remains exposed to volatile policy shifts and potential technological disruption from the accelerating adoption of electric vehicles, which could gradually erode the core market for liquid biofuels, limiting revenue growth prospects over the next decade.
  
• Despite ongoing population growth and rising food consumption in emerging markets, recent shifts toward alternative sweeteners, combined with intensifying international competition from lower-cost sugar producers in Asia, present a structural threat to sugar demand and industry pricing power, which could cap São Martinho's top line as well as future margin improvement.
  
• Although recent land acquisitions are set to provide scale benefits and fixed cost dilution, São Martinho's geographic concentration leaves it vulnerable to regional climate events and frequent weather disruptions, jeopardizing both yield stability and free cash flow consistency, particularly in years when extreme weather impacts yields across its limited operational footprint.
  
• While growing ESG capital flows favor companies with advanced resource management and sustainable agriculture practices, São Martinho faces the risk that rising compliance costs, more stringent standards, and costly certifications will outpace the benefit to cost of capital, compressing net margins over time even as operational complexity rises.

São Martinho Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on São Martinho compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming São Martinho's revenue will grow by 3.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 7.0% today to 10.2% in 3 years time.
• The bearish analysts expect earnings to reach R$829.0 million (and earnings per share of R$2.5) by about August 2028, up from R$513.2 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 12.9x on those 2028 earnings, up from 10.4x today. This future PE is greater than the current PE for the BR Food industry at 10.2x.
• Analysts expect the number of shares outstanding to decline by 1.22% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 19.04%, as per the Simply Wall St company report.

São Martinho Future Earnings Per Share Growth

Risks

• Persistent climate volatility, including heat, drought, and rainfall irregularities in key growing regions, has negatively impacted sugarcane yields and productivity for São Martinho over the past decade, heightening the risk that future extreme weather will further reduce production volumes and thus depress revenue.
  
• Prolonged periods of lower sugar and ethanol prices, driven by unfavorable market conditions and shifting industry demand toward ethanol or away from sugar, have resulted in margin compression, with instances such as negative operating margins in sugarcane ethanol and limited reduction in unit costs, putting sustained pressure on net margins.
  
• The company is committing significant capital expenditure, with a R$1.1 billion investment in new corn-based ethanol capacity and associated working capital, which, if commodity or product prices fall or costs rise, could lead to higher leverage and a drag on free cash flow, with potential adverse effects on earnings.
  
• Intensifying regional competition from new corn and ethanol projects, along with potential oversupply of byproducts like DDG and meal, could erode São Martinho's market share and pricing power, raising the risk of revenue and margin declines if demand fails to absorb new capacity.
  
• Ongoing operational dependence on a concentrated geographic footprint with limited expansion opportunities means São Martinho remains highly exposed to Brazilian land regulation, environmental costs, and regional market dynamics, potentially increasing cost structure and earnings volatility in future adverse cycles.

Valuation

• The assumed bearish price target for São Martinho is R$20.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of São Martinho's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of R$39.0, and the most bearish reporting a price target of just R$20.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be R$8.2 billion, earnings will come to R$829.0 million, and it would be trading on a PE ratio of 12.9x, assuming you use a discount rate of 19.0%.
  
• Given the current share price of R$16.29, the bearish analyst price target of R$20.0 is 18.6% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.