Sunday, December 07, 2008
Sugar appears to be one of the few sectors that offers potential for strong earnings growth combined with good visibility over the next two years, as the economy enters a lean phase. With the sugar cycle likely to turn from a surplus to a deficit in the current season (Oct 2008-Sep 2009), sugar prices may sustain firm trends. The resulting jump in realisations may help sugar companies deliver strong growth in earnings from their beaten-down levels last year. EID-Parry, a South-based sugar producer, appears a good investment option in this context.
Value in subsidiary
Much smaller than leading sugar players such as Balrampur Chini Mills or Shree Renuka Sugars, EID-Parry appears less vulnerable to spikes in cane costs than the UP-based mills, due to the location of its units in Tamil Nadu. (UP-based mills are currently litigating on SAPs fixed by the State). EID-Parry’s integrated business model and a longer crushing season may also help offset the likely escalation in cane prices over the next year.
At the current market price of Rs 139, the stock’s valuation (trailing P-E multiple of about 23) appears expensive based on standalone earnings in comparison to larger players. But the stock valuation factors in the company’s 62 per cent equity stake in Coromandel Fertilizers, a fertiliser maker with good prospects. EID Parry’s equity stake in Coromandel Fertilizers alone translates into a value of Rs 84 per share at the current market price, valuing EID Parry’s core business at Rs 55 per share. That translates into a modest P-E of about nine times the trailing earnings; these reflect a depressed phase in the sugar cycle. The stock trades at 1.1 times its September 30 book value.
Stability from by-products
EID Parry owns cane crushing capacities of about 17,500 tcd spread over five locations in Tamil Nadu and is an integrated sugar producer, with a 40 kl per day distillery and capacity to cogenerate 65 MW of power from bagasse. Ongoing capital investments are expected to take up crushing capacity to 19,000 tcd over the next year, while adding additional distillery capacity and 20 MW of power.
The company also has a presence in bio pesticides and nutraceuticals. The nutraceuticals business has recently been strengthened through the acquisition of a 48 per cent stake in the US-based Valensa International, a product developer.
After de-merger of the farm inputs division to Coromandel Fertilizers in 2003-04, EID Parry has invested substantially in the sugar business, where it has expanded capacity from 14,000 tcd to 17,500 tcd and added significant facilities for processing by-products.
This has contributed to a changing product mix, with rising contributions from power and alcohol. 2007-08, a lean year for the sugar business, cogeneration and distillery operations contributed 16 per cent of EID Parry’s revenues and nearly 30 per cent of operating profits, partially offsetting segment losses from the sugar business.
Higher contract prices for ethanol, which could have bolstered margins, may not materialise now, given the steep correction in crude oil prices. But contributions from both these businesses may continue to grow on the back of higher volume sales. Tighter cane supplies may also aid better realisations from intermediary products such as molasses and industrial alcohol this year onwards.
EID Parry’s core sugar business saw its earnings (before interest and taxes) peak at Rs 79.6 crore in 2005-06 — the apex of the previous boom in the sugar cycle. Thereafter earnings fell steadily and slipped into losses of Rs 59.6 crore in 2007-08, on weakening sugar prices. A sharp turnaround in profitability is likely this year (FY09), as sugar prices rise in response to the emerging situation of a significant fall in production (from 270 lakh to 200 lakh tonnes), tight supplies and lower year-end inventories.
Sugar prices have already firmed up by 33 per cent over the last year and hold potential for further upside, should actual output during the ongoing crushing season be revised lower. With the inflation threat now receding sharply, policy intervention to curb any uptrend in sugar prices also appears less likely than it was a few months ago.
Comfortable on cash
Apart from the prospect of strong earnings growth, low levels of leverage in EID-Parry’s consolidated balance-sheet (1.5:1 as of March 2008) and improving cash flows from operations may help it fund its expansion plans over the next couple of years without significant increases in financing costs.
A cash consideration of Rs 747 crore received in July 2008 from the divestiture of equity holdings in Parryware Roca, also allows room to pay down debt and fund investment plans. This also leaves sufficient resources for the company to implement its recently announced buyback offer, expected to absorb a maximum of Rs 47 crore.
The offer, set to open on December 15, intends to buy back 10 per cent of the outstanding equity through the open market at a maximum price of Rs 160 per share. The buyback may provide downside protection for investors in the stock.