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Shree Renuka Sugars: Management meeting takeaways
• Curious case of high current liabilities
• Price of raw sugar hedges moved up to US cents23 per lbs from US cents20
• Refining margins have improved a bit to US$100/ton
• We retain our REDUCE rating with a revised target price of Rs75 (Rs90 previously)
Shree Renuka Sugars (SHRS)
Sugar
Management meeting takeaways. We met the management of Shree Renuka Sugars
(SHRS). Key takeaways: (1) High level of current liabilities in the SA business is due to high
levels of supplier credit (270 days) for raw sugar which attracts interest payments. This
means some part of the current liabilities is actually short-term debt, (2) raw sugar hedges
moved to US cents23/lbs and (3) improving refining margins. We are concerned about high
levels of trading income in FY2010 profits (Exhibit 3). Retain REDUCE with a TP of Rs75
Curious case of high current liabilities
As per the FY2010 annual report, the company had almost negligible working capital (despite
Rs11 bn of inventory) in the standalone business. The current liabilities as of September 2010 at
Rs19 bn form ~35% of the net sales for the year (Rs55 bn) and if one excludes trading revenues of
Rs16 bn, they form even larger proportion of sales (Rs39 bn) at 50%.
As per the company, it gets a credit period of 270 days from the suppliers (trading companies)
of raw sugar (in the refining business) for which it is charged interest at a rate of ~3-3.5%
p.a. This means a portion of this supplier credit is actually short-term debt which should be
kept in mind while valuing the company. Few questions still remain, for which we would seek
clarification from the management—(1) why would any trading company give a credit period of
270 days in a business where the duration of refining cycle itself is 45 days, and (2) why would a
trading company, working at spreads of 2-3%, assume so much risk on its receivables?
Price of raw sugar hedges moved up to US cents23 per lbs from US cents20
The company has moved up the price of its raw sugar hedges from US cents20 to 23 per lbs.
Almost 85% of production from its Brazilian operations has been hedged at the above price.
Though the exact hedging strategy has not been disclosed by the company, we were told that it
has bought put options for hedging which leaves the upside open in case raw sugar prices move
higher than US cents23 per lbs.
Refining margins have improved a bit to US$100/ton
The refining margins (white-raw spread) have improved for the month of May 2011 (Exhibit 2). We
note that improvement in refining margins should not be taken to make a case for earning
upgrades, as even higher margins are necessary for the company to realize an EBITDA of US$40-
50 per ton which the street is modeling for the refining business.
We retain our REDUCE rating with a revised target price of Rs75 (Rs90 previously)
We are introducing our consolidated earning estimates (including Brazilian business) for SHRS. We
value the company at 6.5X March 2012E EBITDA and retain REDUCE with a TP of Rs75.
Very high contribution of trading income in FY2010 PAT
Trading income forms a very high proportion of the consolidated PBT for FY2010. As per the
consolidated segmental results reported by the company, trading profits contributed 43% of
the total EBIT of the company. If one also includes other income which is primarily on
account of gains on currency, almost 70% of the total earnings at the PBT level are
contributed by trading income and forex gains.
In our opinion, such high income from trading is unsustainable and accordingly we assume
very low contribution of trading in our earning estimates for SHRS. We estimate ~Rs6.7 bn
and Rs 0.8 bn for trading business, at the sales and the EBITDA levels, respectively for
FY2012E and FY2013E, which is low as compared to FY2010.
A large section of the Street has built in high contribution from trading business in
the future years as well. In such a case, the multiples being used to value the
company should be lowered to account for the risk in the trading business.
We have been bearish on raw sugar prices
We have been highlighting our concern (read our update dated February 14, 2011) on high
price of raw sugar in global markets. Since our last update (February 14, 2011), raw sugar
prices have corrected by 15% from US cents32 at that time. We would wait till a further
correction before taking a positive view on the same.
To back our argument, we have compared the current prices of various soft commodities
(wheat, rice, soy, corn) to their 10-year average prices. According to us, the 10-year average
price would represent the normalized price across commodities at which the returns to a
farmer over multiple cycles would more or less be equal as:
10-year average price represents the normalized price across multiple crop cycles.
Farmer chooses to cultivate a particular crop based on the expected financial returns as
compared to other crops. Each of these crops being replacements for each other
depending on their relative financial returns, cropping patterns should shift among
various crops so as to make financial returns in each of them broadly equal over multiple
crop cycles.
If the above assumptions are correct, then the comparison of ratio of current price as compared
to the 10-year average would also be indicative of the relative profitability among various crops.
As per Exhibit 5, sugar is at the highest level compared to its 10-year average price as
compared to other soft commodities. According to us, it means that sugarcane would be
the most profitable crop (among the above-mentioned crops) and also, room for correction
in sugar prices is much more than other soft commodities. As of now, we are computing our
earnings for the Brazilian companies at US cents24 and 25 for FY2011E and FY2012E,
respectively.
Ethanol in Brazil at record prices—100% parity with reference to gasoline
Hydrous ethanol prices in Brazil have seen a spurt in March 2011 due to the short supply of
commodity as crushing has been delayed in South-Central region as sugarcane crop has not
fully matured. Since March represents the last month of the previous sugar season (Brazilian
sugar season April 2010-March 2011), so inventories are bound to be low. The extent of the
shortage could be guessed from the fact that ethanol is selling at 100% parity to gasoline
price whereas as per energy content, it should trade at 70% of the price of gasoline.
According to the management, the prices should cool down once the crushing starts by the
middle of May 2011. SHRS has been able to take advantage of the current spurt in ethanol
price because VDI has started crushing as it is in the state of Parana where crushing has
already begun. As of now, VDI is maximizing the production of ethanol as the sugar
equivalent price of ethanol is ~US cents26, which is very remunerative.
We retain our REDUCE rating with a revised target price of Rs75 (Rs90 previously)
We are introducing our consolidated numbers for SHRS. We value SHRS at 6.5X March
2012E EBITDA and have a target price of Rs75. We retain our REDUCE rating due to limited
upside from the current price.
We value SHRS at Rs75 per share
Valuation table for SHRS, (Rs mn)
March-2012E
EBITDA 18,159
Less: Minority share of RDB EBITDA 4,547
EBITDA (SHRS share) 13,612
EV/EBITDA (X) 6.5
EV 88,479
Net Debt 57,995
Less: Minority share of RDB debt 19,321
Net Debt (SHRS share) 38,675
Equity value 49,804
Value per share (Rs) 74
Source: Kotak Institutional Equities
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Shree Renuka Sugars: Management meeting takeaways
• Curious case of high current liabilities
• Price of raw sugar hedges moved up to US cents23 per lbs from US cents20
• Refining margins have improved a bit to US$100/ton
• We retain our REDUCE rating with a revised target price of Rs75 (Rs90 previously)
Shree Renuka Sugars (SHRS)
Sugar
Management meeting takeaways. We met the management of Shree Renuka Sugars
(SHRS). Key takeaways: (1) High level of current liabilities in the SA business is due to high
levels of supplier credit (270 days) for raw sugar which attracts interest payments. This
means some part of the current liabilities is actually short-term debt, (2) raw sugar hedges
moved to US cents23/lbs and (3) improving refining margins. We are concerned about high
levels of trading income in FY2010 profits (Exhibit 3). Retain REDUCE with a TP of Rs75
Curious case of high current liabilities
As per the FY2010 annual report, the company had almost negligible working capital (despite
Rs11 bn of inventory) in the standalone business. The current liabilities as of September 2010 at
Rs19 bn form ~35% of the net sales for the year (Rs55 bn) and if one excludes trading revenues of
Rs16 bn, they form even larger proportion of sales (Rs39 bn) at 50%.
As per the company, it gets a credit period of 270 days from the suppliers (trading companies)
of raw sugar (in the refining business) for which it is charged interest at a rate of ~3-3.5%
p.a. This means a portion of this supplier credit is actually short-term debt which should be
kept in mind while valuing the company. Few questions still remain, for which we would seek
clarification from the management—(1) why would any trading company give a credit period of
270 days in a business where the duration of refining cycle itself is 45 days, and (2) why would a
trading company, working at spreads of 2-3%, assume so much risk on its receivables?
Price of raw sugar hedges moved up to US cents23 per lbs from US cents20
The company has moved up the price of its raw sugar hedges from US cents20 to 23 per lbs.
Almost 85% of production from its Brazilian operations has been hedged at the above price.
Though the exact hedging strategy has not been disclosed by the company, we were told that it
has bought put options for hedging which leaves the upside open in case raw sugar prices move
higher than US cents23 per lbs.
Refining margins have improved a bit to US$100/ton
The refining margins (white-raw spread) have improved for the month of May 2011 (Exhibit 2). We
note that improvement in refining margins should not be taken to make a case for earning
upgrades, as even higher margins are necessary for the company to realize an EBITDA of US$40-
50 per ton which the street is modeling for the refining business.
We retain our REDUCE rating with a revised target price of Rs75 (Rs90 previously)
We are introducing our consolidated earning estimates (including Brazilian business) for SHRS. We
value the company at 6.5X March 2012E EBITDA and retain REDUCE with a TP of Rs75.
Very high contribution of trading income in FY2010 PAT
Trading income forms a very high proportion of the consolidated PBT for FY2010. As per the
consolidated segmental results reported by the company, trading profits contributed 43% of
the total EBIT of the company. If one also includes other income which is primarily on
account of gains on currency, almost 70% of the total earnings at the PBT level are
contributed by trading income and forex gains.
In our opinion, such high income from trading is unsustainable and accordingly we assume
very low contribution of trading in our earning estimates for SHRS. We estimate ~Rs6.7 bn
and Rs 0.8 bn for trading business, at the sales and the EBITDA levels, respectively for
FY2012E and FY2013E, which is low as compared to FY2010.
A large section of the Street has built in high contribution from trading business in
the future years as well. In such a case, the multiples being used to value the
company should be lowered to account for the risk in the trading business.
We have been bearish on raw sugar prices
We have been highlighting our concern (read our update dated February 14, 2011) on high
price of raw sugar in global markets. Since our last update (February 14, 2011), raw sugar
prices have corrected by 15% from US cents32 at that time. We would wait till a further
correction before taking a positive view on the same.
To back our argument, we have compared the current prices of various soft commodities
(wheat, rice, soy, corn) to their 10-year average prices. According to us, the 10-year average
price would represent the normalized price across commodities at which the returns to a
farmer over multiple cycles would more or less be equal as:
10-year average price represents the normalized price across multiple crop cycles.
Farmer chooses to cultivate a particular crop based on the expected financial returns as
compared to other crops. Each of these crops being replacements for each other
depending on their relative financial returns, cropping patterns should shift among
various crops so as to make financial returns in each of them broadly equal over multiple
crop cycles.
If the above assumptions are correct, then the comparison of ratio of current price as compared
to the 10-year average would also be indicative of the relative profitability among various crops.
As per Exhibit 5, sugar is at the highest level compared to its 10-year average price as
compared to other soft commodities. According to us, it means that sugarcane would be
the most profitable crop (among the above-mentioned crops) and also, room for correction
in sugar prices is much more than other soft commodities. As of now, we are computing our
earnings for the Brazilian companies at US cents24 and 25 for FY2011E and FY2012E,
respectively.
Ethanol in Brazil at record prices—100% parity with reference to gasoline
Hydrous ethanol prices in Brazil have seen a spurt in March 2011 due to the short supply of
commodity as crushing has been delayed in South-Central region as sugarcane crop has not
fully matured. Since March represents the last month of the previous sugar season (Brazilian
sugar season April 2010-March 2011), so inventories are bound to be low. The extent of the
shortage could be guessed from the fact that ethanol is selling at 100% parity to gasoline
price whereas as per energy content, it should trade at 70% of the price of gasoline.
According to the management, the prices should cool down once the crushing starts by the
middle of May 2011. SHRS has been able to take advantage of the current spurt in ethanol
price because VDI has started crushing as it is in the state of Parana where crushing has
already begun. As of now, VDI is maximizing the production of ethanol as the sugar
equivalent price of ethanol is ~US cents26, which is very remunerative.
We retain our REDUCE rating with a revised target price of Rs75 (Rs90 previously)
We are introducing our consolidated numbers for SHRS. We value SHRS at 6.5X March
2012E EBITDA and have a target price of Rs75. We retain our REDUCE rating due to limited
upside from the current price.
We value SHRS at Rs75 per share
Valuation table for SHRS, (Rs mn)
March-2012E
EBITDA 18,159
Less: Minority share of RDB EBITDA 4,547
EBITDA (SHRS share) 13,612
EV/EBITDA (X) 6.5
EV 88,479
Net Debt 57,995
Less: Minority share of RDB debt 19,321
Net Debt (SHRS share) 38,675
Equity value 49,804
Value per share (Rs) 74
Source: Kotak Institutional Equities
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