DBRS Assigns Provisional Rating of B (high) to GreenField Ethanol; Issuer Rating BB (low)

DBRS has today assigned an Issuer Rating of BB (low) to GreenField Ethanol Inc. (GreenField or the Company) with a Stable trend. The rating recognizes the Company’s higher-than-average risk in its business profile due to the very challenging environment of the ethanol industry. Currently, the fuel ethanol business in North America is barely profitable, and the industry is primarily supported by government incentives. DBRS has also provisionally assigned a recovery rating of RR5 and an associated instrument rating of B (high) to the Senior Secured Second Lien Guaranteed Notes of GreenField. The trend on the notes is Stable.

GreenField is the largest ethanol producer in Canada, with a business profile much stronger than its industry peers. The Company’s operations are concentrated in Ontario and Québec where there is a large supply deficit in ethanol. The proximity of the Company’s production facilities to its suppliers (corn farmers) and customers (gasoline producers) strengthens its cost-competitiveness as fuel ethanol is very transportation sensitive. Furthermore, the Company has a substantial portion (over 90%) of its production tied to take-or-pay contracts with three major gasoline producers, adding to sales stability. GreenField is also a leading producer and marketer of bulk industrial alcohol and packaged alcohol in Canada. These, together with distillers’ grains, a co-product used for animal feed, account for 43% of 2010 revenue, providing product diversity to the Company. (Fuel ethanol accounts for 57% of 2010 revenue.)

Despite its strong market position and improving financial performance, the Company still faces significant headwinds. The fuel ethanol business is uneconomic currently, with the bulk of GreenField’s profit margin coming from government incentives. Fiscal problems with all levels of government in Canada have added to the uncertainty as to whether these government incentives are sustainable. Any negative development to these incentive programs could materially impact the financial well-being of industry participants, including GreenField.

Nevertheless, the current rating is supported by GreenField’s ability to mitigate the major risks affecting its operations: (1) government incentive payments account for most of the profitability of this Company and legislation in Canada requiring a minimum ethanol content of 5% in gasoline will be difficult to change. Moreover, the government incentives are in the form of binding contracts which are not likely to be withdrawn before their expiry in 2015/2016. (2) The Company has a strong risk management process. Adopting sophisticated hedging techniques and active monitoring enables the Company to minimize risks to its profit margins. While corn and ethanol have a better correlation, there is little correlation between corn/ethanol and gasoline. The Company has overcome this with: (a) sophisticated hedging; (b) diversification of product, as only 57% of revenue is fuel ethanol, with 43% of revenue spread across three other product lines; and (c) a transportation cost advantage, as both corn and ethanol, which are bulky products, are located close to market. (3) The remaining life of the take-or-pay contracts is 1.5 years to 5.5 years, but this pertains only to the 57% of revenue which is fuel ethanol. The other 43% of revenue is spread across three product lines. This, plus the legal requirement in Canada of a minimum ethanol content of 5% in gasoline (which will be difficult to change), should ensure a ready market for the ethanol produced by the Company. (4) Technology risk exists, as lower-cost biomass such as waste wood could be used to replace high-cost corn. The new technology is five to ten years away from development, and the Company is applying R&D to help discover this technology; the risk is in the future and the Company is addressing it. (5) The Company’s leverage is aggressive, caused by borrowings to fund the ethanol capacity expansion by 50% over the last two years amid the worst recession in 70 years. The Company benefits from: (a) zero dividends; (b) no taxes to be paid for many years; and (c) a 50% capacity addition in 2007-08. This gives GreenField the ability to reduce net debt by up to $50 million per year after 2012, and bring debt down to more acceptable levels.

However, DBRS notes that the risk associated with the bad publicity of ethanol is hard to quantify, and about 40% of the U.S. corn crop is used in ethanol production, which has raised the price of corn and food across the world, indirectly contributing to food riots in Africa, Asia and Latin America. New technology is being developed to substitute biomass such as waste wood for corn in the manufacture of ethanol, but this is at least five to ten years away. Thus, DBRS believes that the industry would be criticized for contributing to high food prices as world weather fluctuates and droughts and floods occur, affecting world food production.

Despite GreenField’s strong market position and a competitive cost position, the Issuer Rating is limited to BB (low) because there are many risks facing the Company, especially the uncertainty regarding the availability of government incentives beyond the current mandate which expires in 2015/2016. The Company will have to prove that it can overcome these risks before the rating is raised.

Pursuant to our rating methodology for leveraged finance, DBRS has created a default scenario for GreenField in order to analyze when and under what circumstances a default could hypothetically occur and the potential recovery of the Company’s debt in the event of such default. The scenario assumes a sharp decline in gross margin due to a drop in demand for gasoline and lower government incentives. DBRS assumes that the Company will receive a waiver from its lenders for breaching the credit facility covenants in 2012, but ongoing poor performance leads to a restructuring of its finances in 2013. DBRS deems that the liquidation approach is more appropriate in assessing the recovery value for the debtholders. Based on the default scenario, the Senior Secured Second Lien Guaranteed Notes have a recovery estimated between 10% and 30%, hence the assigned recovery rating of RR5 and the provisional instrument rating of B (high).

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodologies are DBRS Rating Methodology for Leveraged Finance and Rating Companies in the Industrial Products Industry, which can be found on our website under Methodologies.