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Sunday, April 29, 2007

Shree Renuka Sugars: Hold


Investors with a two/three-year perspective can retain their exposure in the Shree Renuka Sugars stock at the current price. This recommendation follows an earlier "book profits" recommendation on the stock at the Rs 1,030 levels. The revision in outlook is based on the stock's much cheaper valuations at the current price levels and the possible upside to stock price arising from the recent completion of the company's expansion projects.

Though the earnings outlook for the sugar sector, in general, appears bleak in the light of the weak trends in the domestic and global prices, Renuka Sugars may remain an out-performer on account of a recent scaling up of capacities and new revenue streams from the sale of ethanol and other by-products. The stock trades at about eight times its estimated FY-07 earnings (year-ending September 2007).

Scaling up production

Renuka Sugars raised funds through an IPO in October 2005 to substantially scale up its production, refining, ethanol and power cogeneration capacities that were spread across Karnataka and Maharashtra. The capex plans, which included cane crushing capacity of 12,500 tcd and cogeneration facility of 23.5 MW, were revised upwards after the IPO, to 20,000 tcd and 50 MW respectively. The company also flagged off a new 2,000 tcd sugar refining unit at Haldia to enable trading operations. The expansion plans envisaged in the IPO have been completed only recently, with the commissioning of crushing and distillery capacities in Munoli of 7,500 tcd and 120 klpd respectively, commissioning of the greenfield 4,000 tcd unit at Havalga and the setting up of the 6000 tcd unit at Athani. Given that each of these expansion projects have been completed in phases between December 2006 and March 2007, they can be expected to contribute to revenues and earnings only from the current quarter.

No doubt, the substantial ramp-up in the company's production capacity has been timed, rather unfortunately, to a downturn in the domestic sugar cycle. Domestic sugar prices have declined nearly 30 per cent over the past year after a series of upward revisions in domestic sugar output estimates. These revisions have left the latest production estimate for the 2006-07 season (ending September) at over 260 lakh tonnes, doubling sugar inventories to about 100 lakh tonnes at the end of season — a full six months' consumption.

Margins under pressure

With inventories at a comfortable level, and next year's sugar output forecast to grow further to 280 lakh tonnes, prices may remain in the depressed mode for some time to come. Even the recent lifting of the export ban and the incentives announced by the government may not provide significant succour from surplus stocks in the domestic markets. Global sugar prices have corrected significantly on the back of excess supply in the current crop year and expectations of a higher Indian output.

These factors suggest that the company's margins may be under pressure in the coming quarters. Declining sugar prices have already contributed to a sedate financial performance from the company in the quarter-ended March 2007, with consolidated net profits declining by almost half to Rs 22.9 crore in this quarter, despite an expansion in revenues.

Moderate growth

However, Renuka Sugars still appears well placed (compared to peers in the sector) to deliver moderate earnings growth over a one/two-year time-frame. For one, going forward, lower realisations on sugar may be offset partially by the substantial volume growth from the recently expanded capacities.

Second, with the company successfully bidding for contracts to supply ethanol to the oil marketing companies, it is set to scale-up its ethanol supplies to these companies from about six million litres a quarter to about 12 million litres over the few quarters. Though this is a fixed price contract (realisations at Rs 21.50 per litre), the higher ethanol sales would add directly to the bottomline. The company is among the largest ethanol suppliers in the domestic market. Third, with its factories located mainly in Karnataka and Maharashtra in surplus cane areas, the company faces relatively low competition for procurement of cane and low-cost pressures on this score. Fourth, the recent lifting of the export ban on sugar could enable the company to scale up its trading operations, which would contribute additional revenues. Export opportunities for ethanol and any realisations from carbon credit would be an added bonus.

In any case, locational advantages associated with the company's mills, its integrated processes and the ability to process raw sugar, all contribute to an extended crushing season and high operational efficiency and productivity for the company's operations. In light of these factors, shareholders can retain the stock in the hope of some upside to the price.