Vitro Default `High Probability' After Losing Gas Bet

Oct. 21 (Bloomberg) -- Vitro SAB, the century-old Mexican glassmaker which sells in more than 45 countries, may be forced into creditor protection because of derivative losses, according to analysts at ING Groep NV and Deutsche Bank AG.

Vitro's $700 million of 9.125 percent bonds due in 2017 are trading at a bid price of 29.5 cents on the dollar, reflecting concern the company doesn't have enough cash to meet margin calls stemming from derivative losses, said Eric Ollom, a debt analyst with ING in New York. The bonds traded at 80.30 cents on Sept. 8.

"Will Vitro make it? It's questionable,'' Ollom said of the company's ability to make its debt payments. "There's a certain amount of speculation against the company.'' Standard & Poor's said on Oct. 14 it may lower Vitro's corporate debt rating of B, four levels below investment grade.

Vitro losses are part of widespread problem in Latin America, where companies face paying billions of dollars on derivatives, mostly linked to a sudden drop of currencies in the region. The Mexican government is offering loan support for companies after the country's third-largest retailer declared bankruptcy because of losses from bad currency bets. Brazil may follow suit.

Monterrey-based Vitro is Mexico's largest glassmaker and says its Binswanger Glass unit is the biggest full-service glass retailer in the U.S. with more than 100 stores in 22 states. The company increased its purchases of hedges this summer to lock in natural-gas prices when the fuel rose to near record highs on concern it would continue to climb.

The strategy backfired. Vitro announced Oct. 10 that it had losses of $227 million from derivatives on natural gas, the Mexican peso and interest rates. Derivatives are contracts used to hedge risks and are derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates.

'Operations Continuity'

Instead of continuing to rise, U.S. natural-gas futures have fallen by almost half to $6.88 per million British thermal units from a high this year of $13.58 on July 3. Prices have declined on concern natural-gas demand will weaken as economies around the world slow.

"The way the bonds are trading, I would say the market is interpreting that as a high probability'' of Vitro having to seek creditor protection, said Anne Milne, head of Latin America corporate bond research at Deutsche Bank in New York.

Vitro is "currently complying with its obligations,'' company spokesman Albert Chico said in an e-mail yesterday. "However, due to the severe and unexpected financial markets volatility, it is maintaining a close contact with its creditors with the purpose of trying to adjust such agreements to the unexpected and extraordinary conditions of the international market.''

"Vitro's objective is to assure its operations continuity and to have enough liquidity in order to face its obligations,'' he said.

Vitro fell 16 centavos, or 2.7 percent, to 5.84 pesos at 4:12 p.m. New York time in Mexico City trading. The shares have lost 76 percent this year.

Retailer Bankruptcy

Southwest Airlines on Oct. 16 posted a third-quarter loss of $120 million, its first loss in 17 years, because of charges of $247 million related mostly to jet-fuel futures.

Controladora Comercial Mexicana SAB, Mexico's third-largest retailer, declared bankruptcy on Oct. 9 after failing to raise cash to meet margin calls on losses of $1.08 billion of financial derivatives related to the Mexican currency. Companies including Cemex SAB, Gruma SAB and Grupo Industrial Saltillo SAB also reported derivative losses, mostly tied to the currency.

The peso has lost 25 percent against the dollar since early August as investors began pulling investment out of Mexico on concern the U.S. credit crunch would spread to emerging markets. The sudden drop to 13.14 pesos per dollar today from a high this year of 9.86 pesos on Aug. 4 caught many companies on the wrong side of bets the Mexican currency would remain strong.

Derivative Losses

Brazilian pulp maker Aracruz Celulose SA took a charge of about $1 billion related to currency futures, causing the company to post a quarterly loss on Oct. 17 for the first time in six years. Sadia SA, Brazil's second-largest food company, estimated its derivative losses at 760 million reais ($347 million). In the last month, the Brazilian currency has dropped 18 percent to 2.20 reais per dollar.

Gruma, the largest producer of corn flour in Mexico and the biggest tortilla maker in the U.S., racked up derivative losses of $684 million as of Oct. 8, raising investor concern over the company's ability to pay. Gruma's $300 million of 7.75 percent perpetual bonds traded at a bid of 49 cents on the dollar on Oct. 17, according to Deutsche Bank AG.

"Nobody saw it coming,'' said Carlos Legaspy, president of Precise Investment Management in San Diego, who owns bonds in Gruma, Comercial Mexicana and Cemex. "It's really shaken everybody to the core.''

Winner to Loser

Asked if Gruma would default, Legaspy said: "I think the bonds are trading at 50 cents on the dollar just because people don't know. I think the company has been contributing to it just by being quiet.''

Gruma wasn't trying to speculate with the peso, Chief Financial Officer Raul Alonso Pelaez said in an Oct. 13 interview. The company's long-time position on the Mexican currency turned from winner to loser because of the sudden and "impressive'' decline of the peso, he said.

"We have always had these kind of currency operations,'' Pelaez said. "The most recent ones were made as the dollar began to be seen as a weakness at the beginning of the sub-prime situation.''

Unlike other Mexican companies that bet on the peso, only $33 million of Vitro's derivative losses are linked to the currency or interest rates, the company said.

Lack of Cash

Vitro's losses are complicated by its lack of cash on hand and its inability to borrow on short notice, Milne said. At the end of June, the glassmaker had $44 million of unrestricted cash in its treasury, down from $104 million at the end of March and $151 million at the end of 2007.

"In this market, a company like Vitro has a much more difficult time accessing financing,'' Milne said.

Vitro may gain some relief from the Mexican government, which announced on Oct. 16 a program to help companies that face difficulty rolling over short-term debt.

Government-owned development banks will offer 72 billion pesos ($5.48 billion) to guarantee as much as 50 percent of company commercial paper issues, the Mexican government said late last night. In Brazil, government banks may also offer loans to companies in trouble, Planning Minister Paulo Bernardo said Oct. 17.

'Insurance' Cost

Vitro used hedges to lock in natural gas at about $10.20 per million Btu for the rest of this year and part of 2009, Chief Financial Officer Enrique Osorio said in a September interview.

"Nobody was predicting it would drop,'' said Osorio, who seeks advice on natural-gas prices from analysts and consulting firms.

Osorio said in July he boosted Vitro's futures contracts to cover 85 percent of its needs for the rest of 2008, up from 40 percent in the first half of the year. The company spent about $160 million on natural gas to fire its glass-making operations in the 12 months ended in June.

Vitro uses hedges to give it predictable fuel costs so it can plan better and attempt to recover any increases through higher prices to customers, Osorio said. Natural gas accounts for about 60 percent of what it spends for energy, which is about 14 percent of the cost of sales.

"If you have a valuable asset, you're going to want to take out insurance on that asset,'' Osorio, 56, said in the interview. "This is insurance and it has a cost.'' He declined to estimate the company's hedging price for natural gas during the third quarter.

Vitro's losses on natural-gas futures of about $190 million are high compared with the company's annual fuel needs, Milne said.

"That leaves one to believe that there was some leverage imbedded into whatever hedging strategy they applied,'' she said.