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July 2, 1997


Foreign institutional investors see 'boom', flock to sugar industry

The one industry that appears to have moved quietly into the preferred list of a number of foreign institutional investors in the country is sugar. Analysts see a boom in the next couple of years -- and I would be inclined to agree.

The basic rationale for the boom is: the cane output has dropped all over the country, resulting in a lower sugar production for 1996-97 season. The sugar industry puts an estimate of 13 million tonnes for the full season compared with 16.4 million tonnes for the previous season. That is not the end of the decline: for the coming season, the sugar industry does not expect production to be anything higher than 11 million tonnes.

This leads us to a strange situation: The industry foresees an improvement in profits even though the overall output is going to drop. Which means that much of the increase in profits is expected to be driven by an increase in the price of sugar in the retail market. In other words, the industry expects prices to increase to such an extent that it will more than neutralise the downtrend in output registered by various manufacturers across the country.

Which is what makes bargain-hunting in the sugar industry a difficult proposition. Look at the number of variables that one has to look at:

* The production drop is likely to be sharper in South India than in Uttar Pradesh, so prices are likely to rise faster in the South than the North (this has already begun to transpire).

* Companies in UP may have varying crushing records over different regions, meaning that a company in one region may have crushed far more than the average for that region.

* In the cement industry -- or other process industries -- for example, it is easier to arrive at estimated production figures. In the sugar industry, on the other hand, the production of a company is more likely to be influenced by its internal efficiency at managing its costs. This is manifested in its recovery. This varies considerably from company to company in the same region.

* Recovery by itself is not an extremely reliable indicator either. If a company shows a 9.95 per cent recovery in one season, it does not mean that it will work at the same efficiency level the following season. The following season, if the summer is harsher and the cane-coordination loose, the recovery could drop.

* The installed capacity is again no indicator of what the company is likely to crush. A company with a crushing capacity of 4,000 tonnes can crush more than one with 5,000 capacity -- if the former works longer in the season.

* To make things more complex, the crushing record is again no indicator of how well a company is going to do in a particular year. A company can crush higher than all the competitors in its region, but if 40 per cent of the production has to be surrendered to the government at the non-remunerative levy price, then smaller companies with a 100 per cent freesale record might end up doing better.

* The complexities go on and on. A company that surrenders 40 per cent of its production to the public distribution system can in some instances do better than companies that sell all their output in the open market. This is how: If the former company has a high installed capacity compared to the cane it is likely to crush, there is a greater possibility that it will attract more cane than usual from the farmers. The company finishes its crushing early in the season. As a result, the farmers in this case get cane of their lands faster than usual, leaving them ample time to plant a second crop. This means more income for the farmers. In the following year, they are more inclined to plant more cane. Note how the company which does not have a crushing capacity high enough to finish off all the cane early in the season saves on the investment to set up larger machines and the interest cost to finance them but loses out on the income generated per season.

* A company may be doing everything in its sugar manufacture but might do the one right thing by setting up a co-generation plant to produce electricity. The power could then be sold to the state grid, fetching an even better return than made from selling sugar!

Conclusion: What we need to understand when trying to arrive at a company which is likely to do better than the others in the sugar industry is a lot of inside information. Information on which company is crushing how much, at what recovery -- and selling how much of the output in the freesale market and how much in the non-remunerative levy.

In the absence of privileged information -- which, by the way, is now a crime in the eyes of SEBI -- the fastest thing is not to chase the temporary but play the long-term. Not to get influenced by how much a company is likely to crush in one season but its long-term crushing and expansion scenario. Sugar manufacturers can do well in one year when the tide raises the level of water for all manufacturers. But few can move out into the sea when the tide rolls back.

The clues are not hard to find. The results for 1996-97 have an interesting story to tell. Thiru Arooran has seen its worst year in a long time while Dhampur posted embarrassing drop in its bottomline for 1995-96 (September year-end). Bajaj Hindustan registered a huge loss in 1995-96.

On the other hand, the one company that has done well in years bad as well as good is the Calcutta-based Balrampur Chini Mills. The company posted a pre-interest profit of Rs 570 million for 1996-97 and a post-tax bottomline of Rs 230 million on an equity of Rs 187.2 million. If such a company can do better in possibly the worst sugar year in recent times, then it doesn't sell a commodity at all. It should not then be considered a commodity company. Result: the stock has moved to a price /earning multiple of around 10 for retrospective results which is some achievement at a time when the broadcast list is selling for a price/ earning of probably less than five.

For those who have the nerve for big chances, Dhampur could well have some steam left in it as its profit estimates for 1996-97 are redrawn. Considering that the company had a huge inventory of sugar as on September 30, 1996, it must have converted it to sales at a good price in the current year. Thiru Arooran, probably the only visible sugar maker who is raking in the profits in electricity generation, is just the kind of stock to attract the FIIs once the management displays stability in its core business. Prudential Sugar at a little above par value is expected to increase profits in 1996-97 (June year-end) and pay a dividend which makes it an interesting candidate for a closer scrutiny.

But if I had to stick my neck out and put my odd rupee on a blind gamble, I would back the Madras-based KCP Limited. The company has a crushing capacity of 9,000 tonnes spread over two units of which one is a freesale unit. Having shed its diversified interests in 1996-97, the company is more strongly focused than before. Its factories are located in a region where the average recovery is 10.50-plus and where the average sugar price this season is higher than the UP average. The equity is around Rs 120 million and the entire company is selling for a market capitalisation of Rs 550 million -- the kind of money KCP made in 1996-97 post-restructuring.

I won’t fall off my chair if KCP’s pre-interest profit from its core operation exceeded this in 1997-98. Now if it only had Balrampur’s perception....

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