Irrigation And Biomethane Projects Could Enhance Future Production Amid Market And Weather Risks

Key Takeaways

• Increased irrigation investment promises enhanced yields, boosting revenues from higher sugar and ethanol production.
  
• Biomethane project and competitive ethanol positioning enhance cost savings, revenues, and net margins.
  
• São Martinho faces revenue and earnings risks due to weather variability, market conditions, and a shift in production from sugar to ethanol.

Catalysts

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

• Increased investment in irrigation technology is expected to enhance sugarcane yields by 15% to 20%, potentially boosting future revenues through higher sugar and ethanol production.
  
• Introduction of the biomethane project, anticipated to deliver returns over 30%, offers potential cost savings and additional revenue streams, improving net margins.
  
• An anticipated ICMS tax increase is expected to push up gasoline prices, thereby improving ethanol’s competitiveness and potentially increasing ethanol sales volumes and revenues.
  
• Expectation of a shift towards a higher sugar mix driven by completed capacity expansions allows São Martinho to capitalize on favorable sugar pricing, likely improving future earnings.
  
• Stronger ethanol demand, coupled with advantageous tax conditions in Goiás, suggests potential expansion in higher-margin corn-based ethanol production, enhancing both revenues and profitability.

São Martinho Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming São Martinho's revenue will grow by 2.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 14.9% today to 13.0% in 3 years time.
• Analysts expect earnings to remain at the same level they are now, that being R$1.1 billion (with an earnings per share of R$3.01). However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting R$1.6 billion in earnings, and the most bearish expecting R$551.4 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.8x on those 2028 earnings, up from 6.6x today. This future PE is greater than the current PE for the BR Food industry at 9.9x.
• Analysts expect the number of shares outstanding to decline by 4.02% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 17.62%, as per the Simply Wall St company report.

São Martinho Future Earnings Per Share Growth

Risks

• The recent fires have led to a decrease in sugar production and forced São Martinho to produce more ethanol instead, which could impact overall revenue due to lower sugar prices.
  
• The increase in CapEx due to crop treatment and irrigation projects could strain financial resources and affect net margins if returns are not realized as projected.
  
• São Martinho's financial performance is susceptible to weather changes. Droughts or insufficient rainfall can influence crop yields negatively, impacting revenue.
  
• There is a risk that corn ethanol might not contribute as significantly to EBITDA as expected if market conditions change, potentially affecting earnings.
  
• The company's heavy reliance on future favorable pricing and market conditions for both sugar and ethanol could lead to discrepancies if market dynamics are unfavorable, impacting revenue and earnings.

Valuation

• The analysts have a consensus price target of R$35.133 for São Martinho based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of R$42.0, and the most bearish reporting a price target of just R$30.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be R$8.1 billion, earnings will come to R$1.1 billion, and it would be trading on a PE ratio of 15.8x, assuming you use a discount rate of 17.6%.
  
• Given the current share price of R$22.41, the analyst price target of R$35.13 is 36.2% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• 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.