When Sugar Turns Bitter - Bajaj Hindusthan

With the sugar crushing season almost at its fag end across India, the Indian Sugar Mills Association (ISMA) expects the sugar production in the current season to be around 14.50-15 million tonnes (MT), recording a 45 per cent fall on a YoY basis. And with the expected demand from the domestic markets at 23 MT, the production shortfall might eliminate almost the entire opening inventory of 8.1 MT. As per the ISMA, sugar production in the next season is expected to be at 17-18 MT, a YoY rise of almost 20 per cent on account of the rise in the yield by the sugar mills as well as the higher sugarcane produce due to better acreage.

Looking at these numbers along with this season’s closing stock, it is expected that India might have to import 2-3 MT of sugar in this as well as the next season. Such demand-supply mismatch has led to the spiraling of the sugar prices in the domestic markets from Rs 1,612 per quintal in March 2008 to Rs 2,134 per quintal in March 2009, recording a 32 per cent rise.

And at a time when sugar is turning sweeter for most of the sugar mill owners owing to the up-cycle in the industry, Bajaj Hindusthan (BHL), the largest sugar producer in India and Asia and the fourth largest sugar producer in the world, seems to have gone diabetic due to the higher debt in its books. The current supply shock spells well for most of the integrated players in the sugar industry. And on the same account, we have seen most of the sugar stocks rallying in the past one month. However, there are various factors that will make sugar taste less sweet to the mill owners in the current up-cycle. This includes the higher cost pressures on account of higher cane prices and the government’s priority to control the rising sugar prices.

Company Structure And Capacities
Bajaj Hindusthan is a fully integrated player in the Indian sugar industry with its diversified offerings. Along with sugar, the company is into the business of distillery, cogeneration of power and has recently entered into the business of MDF (medium density fibre) and particle boards. The company, on a consolidated basis, has a total sugarcane crushing capacity of 1,36,000 TCD (tonnes crushing per day) that is highest amongst all the players in the Indian industry, making it the most preferred bet in case of the sugar’s price rise. Having said that, the company will not be able to convert these higher realisations into higher margins on account of it being highly leveraged as compared to its peers like Balrampur Chini. The group has a total distillery capacity of 800 KLPD (kilo litres per day) and a surplus power co-generation capacity of 105 MW.[PAGE BREAK]

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However, despite such high capacities, the company, like every other sugar mill in the current season, operated at lower utilisation levels due to lower cane produced this season. As per the company’s spokesperson, BHL’s capacity utilisation was around 55 per cent in case of sugar. Lesser availability of cane resulted in lower volumes for the company which is evident from the H1FY09 (sugar companies have their year ending as on September) numbers, where the company sold 3,72,270 MT of sugar as against 4,54,363 MT during the same period in the previous year.

Further, due to lower sugarcane and bagasse availability that forms the basic raw material for every by-product, the company’s other businesses like distillery, power co-generation and boards also were badly affected. The company sold 28,100 MT of molasses as against 51,650 MT in the same period last year. The alcohol and ethanol sales during this period were lower at 20,580 KL as against 69,876 KL during the previous year. The company exported 75,579 MWH of power during the year as against 93,887 MWH during the last year.

Interest Cost Hurting Margins
It’s rightly said that one should make hay when the sun shines. Likewise, sugar companies should make the most out of the current situation when the realisations are at their highest. The rise in the price is here to stay till the start of the next season. However, despite having the highest capacities, BHL will not be able to convert such higher realisations into higher margins. This is because the company is highly leveraged wherein its debt, even on a stand-alone basis, stood at Rs 3,409.07 crore. Its debt to equity ratio stood at 2.12 times (excluding the FCCBs of Rs 560 crore) as on September 2008 and that is much higher than its peers in the sugar industry.

This is evident from the fact that in H1FY09, BHL’s interest cost increased from Rs 29.56 crore to Rs 111.18 crore, a whopping 276.12 per cent rise over one year. Such a high interest cost swept the company’s entire profit for the H1FY09. The company has actually posted losses of Rs 58.20 crore (excluding exceptional items) in H1FY09 as compared to the profit of Rs 72.70 crore in H1FY08. However, despite incurring losses from the operation, the company has managed to show profits of Rs 25.45 crore in H1FY09 on account of the change in its accounting policy (AS11), wherein Rs 83.65 crore has been credited to the company’s P&L account.[PAGE BREAK]

The company’s plan to expand its capacity in the last few years had increased its leverage. However, the company has recently announced its decision to raise around Rs 1,500 crore through private placements and it has also recently allotted 1.45 crore shares to its promoters at a price of Rs 52.14 per equity share that are convertible after 18 months to reduce its leverage. Further, it has recently bought back the zero coupon FCCBs of USD 17.93 million, bringing down the total outstanding to USD 101.57 million.

As per the company’s spokesperson, “This issue is mainly to raise the equity and the proceeds will be used to reduce the debt which will help the company in two ways. It will de-leverage the company and improve our debt/equity ratio and secondly, it will bring down the cost of funds so that the savings will directly go to the bottomline.” However, these issues will further result in the increase of the company’s equity base by 10.85 crore equity shares (the dilution in case of private placement has been calculated on the basis of the CMP of Rs 159.65).

Rising Cane Costs
The surplus sugar supply in the last two seasons resulted in lower prices that led to huge cane arrears to the farmers by the mill owners. This resulted in lower cane production for the current season (2008-09) mainly on account of the fall in sugarcane acreage and lower recovery. And to improve the crop acreage, the Prime Minister’s Economic Advisory Council (PMEAC) is said to have suggested that the SMP (statutory minimum price) be fixed at Rs 107 per quintal for the 2009-10 season, while the Commission for Agricultural Costs and Prices has recommended that the SMP should be raised to Rs 125 per quintal. In Uttar Pradesh, where the company has all its mills, the SAP (state advised price) has to be followed which is generally higher than the SMP.

There has been a sharp rise in the sugarcane prices that stood at Rs 150 per quintal in the current season as against Rs 110 last year. Meanwhile, some of the mills in UP have bought cane even at the rate of Rs 200 per quintal. Sugarcane cost forms more than 70 per cent of the sugar companies’ total cost and secondly, as the prices of sugarcane are regulated, it will be a difficult time for the mills in the next season. This is expected to further dent the company’s cash flows.

Valuations & Financial Performance
On a trailing 12-month basis, when most of the sugar companies have managed to grow their bottomline due to higher realisations in the last two quarters, Bajaj Hindusthan has posted a loss of Rs 97.42 crore, excluding its exceptional items which would have further increased its losses. And on a stand-alone basis, for FY08 the company’s EV/EBITDA stood at 15.31 times, which is very high. The counter is currently trading at Rs 163.80 that has rallied from its low of Rs 38.25 by 328.24 per cent since November 2008. We expect the counter to underperform in the coming days. And those who bought it in the recent rally can book profit, while a fresh buy for investors is not recommended.