Left-for-Dead Sugar Bonds Surge 84% for World’s Best Gain

Four months after Grupo Virgolino de Oliveira SA’s notes hit a record low as investors braced for a wave of defaults in Brazil’s sugar industry, they’re proving to be the most-lucrative junk-bond investment in the world.

The company’s $300 million of debt due 2018 has returned 84 percent since slumping to 46 cents on the dollar on Feb. 4, the most among 2,000 speculative-grade bonds tracked by Bloomberg.

Investors including Western Asset Management who bought GVO’s bonds in February were vindicated after the company relied on local bank financing to weather a plunge in sugar prices and a cash crunch that led rival Aralco SA Acucar & Alcool to default in March. Nomura Holdings Inc. predicts GVO’s notes will advance to 91 cents on the dollar after the company borrowed $135 million this week in international bond markets.

“After the bombshells that hit investors last year, the mentality around sugar bonds like GVO was, ‘Sell now, ask questions later,’” Robert Abad, who helps oversee about $55 billion of emerging-market debt at Western Asset, said in an e-mailed response to questions. “For those who turned over stones at GVO during those dark days, patience and hard work have been rewarded.”

Bond Sale

The Ariranha, Brazil-based company sold $135 million of bonds due 2020 to yield 11 percent June 9, data compiled by Bloomberg show. It will use the money to pay down near-term debt.

GVO declined to comment on the performance of its notes or the bond sale.

The company, which operates four mills in Sao Paulo state with total sugarcane crushing capacity of about 12 million tons per harvest year, recently concluded negotiations with domestic banks to refinance outstanding obligations, Moody’s Investors Service said June 9.

Chief Financial Officer Carlos Otto said in February that GVO has a “decades-long relationship” with its lenders, which include Banco do Brasil SA and Itau Unibanco Holding SA. The company also counts state development bank BNDES, whose portfolio of more than $200 billion is larger than that of the World Bank, among its lenders, according to Fitch Ratings.

After reaching a four-year low in late January, sugar prices have climbed 16 percent, outpacing a 5.4 percent gain in the Standard & Poor’s GSCI gauge of 24 commodities. Brazil’s real was little changed today at 2.2320 per dollar as of 11:56 a.m. in New York.

Aralco Default

Brazilian sugar millers, which make up almost half of the world’s exports, faced cash shortages after expanding and producing too much sugar. Aralco halted payment on $250 million of bonds in March after making just one interest payment.

“The expectation is that there’ll be a deficit instead of a surplus for the first time in a few years,” Salim Morsy, a New York-based analyst at Bloomberg New Energy Finance, said in a telephone interview.

On May 28, Fitch cut GVO’s rating one level to B-, six steps below investment grade. Two weeks later, in a report on the new bonds, Fitch analyst Claudio Miori said that the company’s liquidity is under pressure.

“At the average price levels for sugar and ethanol of the last 12 months, GVO’s current operating cash generation should be insufficient to cover interest expenses and the maintenance capital expenditures, leading to the necessity of increasing debt levels in the near future,” he wrote.

GVO’s ability to refinance debt with banks and to tap the international debt market will improve its liquidity and bolster the company’s bonds, according to Western Asset’s Abad.

“Now it has additional financial flexibility,” he said. “That’s important from an operational and risk management perspective, which should give bondholders greater comfort.”

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