International Corporate Bonds - Brazil 5/22/2019 Monthly Update Summary of Calls Macro Overview Exhibit 1 – 5 & 10 YR YTM – US (%) Yield Catcher Despite fierce competition from local debt capital markets – which have been able to 2,80 - Eldorado 8,625% / 2021 (BB-) provide competitive funding for Brazilian corporates YTD, offshore issues have been - Marfrig 8,00% / 2023 (BB-) 2,70 strong. Recent deal activity has been 3-4x oversubscribed thanks to the recent tightening 2,60 Portfolio Builder of longer-term treasuries and solid demand for higher yield bonds (i.e. CSN, Klabin, - Rede D’Or 4,95% / 2028 (BB) Marfrig and JBS). The spread between the 3M and 5YR treasuries moved from -3bps to - 2,50 - Klabin 4,88% / 2027 (BB+) - Cemig 9.25% / 2024 (B) 14bps MoM on as investors remain cautious about the trade-war tensions between China 2,40 and the US. 2,30 Long Duration - Petrobras 5,63% / 2043 (BB-) Brazil’s 5YR CDS has stabilized at 180bps (+9bps MoM) and is trading at 64bps higher than 2,20 Mexico’s CDS (+3bps YoY). Despite the recent progress towards the ongoing pension 2,10 21-Feb-19 13-Mar-19 02-Apr-19 22-Apr-19 12-May-19 Odilon Costa reform and privatizations, the government still has a long road to go in the coming 10YR 5YR 3M Analyst months. Forecasts for economic activity have diminished and Bolsonaro lost some of his Source(s): Bloomberg, prepared by Eleven Research initial popularity following several minor squabbles with the legislative. Brazilian GDP Luis Dotta estimates for 2019 currently stand at 1.24% (vs. 1.9% last month). The local CDS unlikely Exhibit 2 – 5-YR CDS – Selected LatAm Countries Associate Analyst to close further until something meaningful materializes on the political side. 195 Adeodato Netto Meanwhile, Suzano just launched a U$ 1.25bn dual-tranche deal in which the first tranche 180 Chief Strategist 165 comprises of a new 2030 bond. The second part is a new retap of the 2047 notes. The yield on those transactions amounted to 270bps and 340bps over comparable treasuries. 150 Raul Grego Lemos Proceeds should be used toward liability management (2021s) and general corporate 135 Analyst, CNPI purposes. The company has been terming out maturities following the hefty acquisition 120 of Fibria in 1Q19. Future deal activity should remain concentrated among longer-term 105 bonds. Ultrapar is reportedly preparing a bond issuance (~10YR) to finance its capex plans for FY19. 90 21-Feb-19 13-Mar-19 2-Apr-19 22-Apr-19 12-May-19 Brazil Mexico Colombia Source(s): Bloomberg, prepared by Eleven Research ELEVEN FINANCIAL RESEARCH 1 22-May-19 Coverage Universe This initial coverage includes Brazilian corporate bonds that meet the following criteria: (i) investment grade (BBB- or higher) and upper high yield (B- or higher by at least one rating agency), (ii) U$-denominated and (iii) duration of at least one year. In order to ease industry diversification, we prioritized sectors that have two or more ‘Brazilian Issuers’ (corporates that consolidate their operations in Brazil, are mostly backed by assets or guarantees from companies incorporated in Brazil and/or depend primarily on operating cash flow from operations in the country). In some specific cases – normally in which liquidity is high and there are limited comparable issuers – we also include other Latin American companies in our universe. Exhibit 3 – Summary of Calls Strategy Description Baseline Calls Short-term notes (duration up to 3 years) offering and YTW/YTM significantly higher than that of other Brazilian Issuers – at a cost of higher credit risk and lower Eldorado 8,625% / 2021 (BB-) Yield Catcher liquidity. They are best if held until maturity as their returns are not very correlated with other spreads (i.e. sovereign). Investors should monitor company Marfrig 8,00% / 2023 (BB-) fundamentals, especially liquidity and credit profile until maturity. Medium-term bonds that follow market standards for high yield investments (duration of 3 to 7 years) and have low-to-medium credit risk. These securities Rede D’Or 4,95% / 2028 (BB) Portfolio Builder usually offer returns beyond the Brazilian sovereign and are reasonably liquid. Their returns are prone to market conditions and company fundamentals (medium- Klabin 4,88% / 2027 (BB+) to-high correlation on both ends). Cemig 9.25% / 2024 (B) Long-term securities (duration higher than 7 years) are substantially riskier than their counterparts as price volatility tends to be high. Although most securities Long Duration are issued belong to larger companies, certain high yield corporates are also part of this market. These notes are best if held when interest rates are expected to Petrobras 5,63% / 2043 (BB-) decline (improvement on company and/or country fundamentals). Source(s): Bloomberg, TR Eikon, prepared by Eleven Research Credit Calls Eldorado 2021: After failing to clear a U$ 500m 2026 bond in January 2019 due to corporate governance issues, the pulp and paper continued to post strong results and should be able to repay/refinance its short-term maturities. Shareholders J&F and Paper Excellence continue to fight over control over Eldorado. Net debt declined to R$ 6.3bn last quarter from R$ 7.1bn in 1Q18. The company’s results are expected to remain strong thanks to a depreciated BRL and cost competitiveness (cash cost per ton of pulp lower than rival companies Klabin and Suzano). Yet, we no longer have a bullish case on the commodity and do not see further EBITDA growth in the coming quarters as the company is already operating at full capacity. Net leverage amounted to 2x in 1Q19 (vs. 3.1x in 1Q18). Given the lack of liquidity on Eldorado’s 2021, the notes are best if held until maturity. Marfrig 2023: The meatpacker recently placed a new bond U$1bn 7% bond due 2026 and concluded a tender offer for its shorter notes (2019s and 2021s). Although the exercise improved the company’s liquidity profile, it also contributed to leverage. Net debt to adjusted EBITDA amounted to 2.75x last quarter (+0.4x QoQ). The company expects to generate up to U$ 1.5bn in FCF this year. The opening of new beef markets, especially China, and operational ramp up from a positive protein cycle in the US and Brazil could help tightening the company’s credit spread. Nonetheless, we see Marfrig’s 2023s as an attractive carry because of its higher risk profile (beef-only business) and premium relative to JBS’s 2024s. ELEVEN FINANCIAL RESEARCH 2 22-May-19 Klabin 2027: Although Klabin just announced Puma II – a R$ 9bn project to deliver two Kraftliner machines, we do not expect significant deterioration in the company’s credit metrics. Investments will be diluted over the course of five years and the company has stronger EBITDA generation. Back in 2015, when the pulp and paper producer was building Puma I, net leverage amounted to 6.2x. The company’s net leverage is currently at 3.5x (1Q19 numbers adjusted for the new bond issue). The company’s notes trade at a reasonable spread relative to those offered by its peers and Brazil’s sovereign. Suzano has also been raising a lot of debt to finance the acquisition Fibria and we believe it should take some time until Klabin’s competitor reduces indebtedness. Cemig 2024: The electric utilities company posted net leverage of 3x last quarter (vs. 3.5x in 1Q18) thanks to an improvement in market conditions in both segments (generation and distribution). The stronger outlook for hydro-based generators should help Cemig improve liquidity and deleverage this year. The 2024s trade at a reasonable premium and could offer some pick up as the company moves forward with its asset-disposal plan. Rede D’Or 2028: Despite the ongoing brawl with health plan provider Amil, Rede D’Or’s 2028s continue to offer a decent carry. The company launched an even-more-aggressive capex plan in February. Investments are expected to amount R$ 8bn in the coming 5 years (vs. R$ 7n between 2013-2018). Yet, we believe the expansion is not expected to deteriorate the company’s credit profile. The hospital operator has been able to maintain steady margins and control its cash burn. The potential IPO in the coming quarters could potentially result in a price pick up. Petrobras 2043: The state-owned oil & gas company remains highly committed to its deleveraging process amid a more aggressive capex plan. The company has been transparent and accelerated its asset disposal plan, still offering room for price improvement. We continue to monitor oil prices and the company’s pricing policy closely, regardless of stronger metrics on the liability side. Although the Brent price recovered significantly YTD, it is still 25% lower than its latest peak (3Q18). Removed from Call List Minerva 2026: Despite the temporary cancellation of Athena’s IPO, Minerva continued to deleverage organically in 1Q19 thanks to a positive cattle cycle in Brazil and strong export performance. Net debt to adjusted EBITDA amounted to 3.8x in 1Q19 (-0.1x QoQ). The company lifted Athena as a guarantor its 2026s, paid a premium of U$ 7.5 per U$ 1000 and agreed to buy back bonds within a year. Although the IPO to is expected to take place in the coming months, we see less room for a price pick up. We decided to remove the 2026s from our recommendation list as its yield is currently less attractive than Marfrig’s 2026. Vale 2026: Vale’s bonds are again trading close to the sovereign curve – almost at same price prior to the collapse of Mina do Feijao.